One of the most important investment goals that people have is building a nest egg for retirement. As a result of the continuing 2008-2009 economic crisis, however, many people are wondering “Will I ever be able to retire?” In the aftermath of extreme stock market volatility, high unemployment, exposed Ponzi schemes, and decreasing 401(k) account balances, a reassessment of retirement plans may be in order. Below are five thoughts to consider:
• The stock market is very volatile in short time periods, but has historically outperformed bonds and cash assets, especially in long time periods of 15 or more years. Investment volatility is also reduced over long time frames, a principle known as time diversification. Remember that your investment time horizon is the rest of your life…not your retirement date. This means that if you are 45 years old today and live to age 85, you have 40 years for your money to grow through the power of compound interest. Your assets should be invested aggressively enough to offset the effects of taxes and inflation. This means considering some stock or growth funds in your portfolio.
• If you are nervous about the stock market and want to reduce portfolio volatility, avoid aggressive growth funds, sector funds that include only one industry (e.g., technology), and concentrated or “focus” funds that have only a small number of stocks in their portfolio. Instead, consider mutual funds that contain more than one type of asset and, therefore, have less investment risk, such as balanced funds, target date funds, and equity-income funds. A good source of information about mutual funds is Morningstar, a reference tool in libraries and online at www.morningstar.com.
• Investors can reduce investment risk by not concentrating their portfolio in any one company or industry. Periodically compute the percentage of your investments in individual companies and industries. Many financial experts recommend not investing more than 5% of assets in any one company (including an employer, where both your job and your stock investment could be at risk in the event of poor company earnings) and no more than 10% in any one industry (e.g., health care or telecommunications).
• A person’s choice of retirement housing can greatly affect the amount needed to save for retirement. Trading down to a smaller home, say from a $250,000 home to a $150,000 condo, can be a very effective catch-up strategy. Proceeds from the sale, minus sales and moving expenses and the cost of a new home, are available to invest for income. Property taxes, utilities, and maintenance may also be lower with a smaller home. Another way to reduce retirement living costs is to move to a less expensive location in the U.S. or even abroad. The first option, trading down in the area where you already live, is often preferable, however, because many retirees want to remain close to friends, family, and community.
• The longer workers remain in the workforce, the less they’ll need to save for retirement. Continuing to work, even just a few years longer, provides additional income to invest in tax-deferred plans. It also postpones asset withdrawals, which is especially beneficial during market downturns because it provides time for retirement savings account balances to rebound with compound interest. In addition, workers in defined benefit pension plans can increase their benefits by remaining on the job longer because they’ll have more years of service in their benefit calculation. Social Security benefits may also increase. Here’s an example of the relationship between working and the amount of annual savings required to achieve a retirement nest egg goal. If you plan to retire at 62, you must begin- at age 45- saving $13,469 per year to afford $20,000 annual withdrawals at retirement. If you wait until age 68 to retire, you would only have to save $7,701 per year, or a difference of saving $5,768 per year. Six years of additional work can really make a difference in the amount of savings required! This analysis assumes 3.5% inflation, an 8.5% average annual return, and average life expectancy based on U.S. Census Bureau data.
