Will you and/or your spouse outlive your retirement assets? A recent study estimates that 95% of all American Baby Boomers–those born between 1945 and 1964–will die broke, leaving no inheritance for their children and grandchildren. Perhaps even worse, who wants to spend their sunset years in threadbare surroundings worried sick over how to pay for daily necessities?
Saving and investing for your retirement at middle age, you don’t have to join the “95% crowd” but it may require early and aggressive action to avoid the pitfalls of our nation’s most popular retirement funding method–employer sponsored 401(k) plans or self-funded IRA’s. Have you been handing over your retirement savings to an “expert” fund manager who most likely will park the bulk of your money in a common stock mutual fund? Is this the kind of investment risk you desire? Despite recent near record highs, the American stock market has only now recovered to where it was in 2007. Where does it go from here?
First a little history–how did we get into this mess? Back in the 1950’s and 1960’s when my parents were of middle age, their retirement was covered by an employer-sponsored “defined benefit” pension plan. My father’s pension was funded for 32 years by a single, “lifetime” employer. Upon retirement, my father knew precisely how much he would receive per month for the rest of his life and, following his death, how much my mother would receive in “survivor benefits” for the remainder of hers.
Around 1980, employers began avoiding the risk from underfunding these defined benefit plans by replacing them with “defined contribution” plans like the then brand-new 401(k), which has become the most popular retirement instrument for most employers today. For the self-employed, the most common alternative is the tax-advantaged traditional IRA. In both of these instruments, the investment risk has shifted from your employer to you, the employee.
As investment risk-taker, you face three major challenges: 1) how much, if at all, your investment portfolio will appreciate over the years, both before and after retirement, 2) how much annual cash flow it will generate and 3) the threat of significant decline in value of any assets which you will need to liquidate each year to fill the gap between anticipated retirement income and expenses.
Do you want to take a hard look at where you stand today? Here are some eye-opening exercises for those of us at middle age contemplating retirement in 5, 10 or 15 years:
- Exercise 1–Total up all the contributions you have made over the years to your individual IRA or employer sponsored 401(k) retirement plan. (Should you so choose, you can add in any matching employer contributions.) Now write down today’s combined market value of your 401(k) plan and/or individual IRA’s. Is the current value greater or less than the sum of all contributions? What is your cumulative percentage gain or (loss)? What is your average annual percentage gain or (loss).
- Exercise 2–Here’s a more stringent test. Add up the current value of your 401(k) or IRA retirement portfolio to the estimated total “liquidation value” at today’s market for your home, autos and other valuable personal assets. Next add up the total of all your 401(k) or IRA contributions over the years plus balances currently outstanding on your home mortgage, auto loans and any credit cards you don’t pay down each month. Next, estimate and add in the total of all interest charges and fees you have paid to financial institutions over the years on prior and current loans outstanding. Subtract the grand grand total of all interest and fees paid, debt outstanding and cumulative 401(k) and IRA contribtions from the current market value of all your assets, liquid and other. For most, I’m willing to bet the net result is a sizable negative number. What if over the years you had been able to serve as your own bank and had paid all those interest and fee charges to yourself and your family? Even given historical appreciation, if any, in your 401(k) plan or IRA, wouldn’t you be wealthier today and better prepared for retirement?
- Exercise 3–Estimate annual cash flows you will need each year of retirement to fund the joyful, carefree lifestyle you desire. Now examine your 401(k) or IRA retirement potfolio. Without liqidating any assets, how much annual cash flow can you generate from interest, dividends, rents other sources of income. Crucial question: will your retirement portfolio as presently structured generate the level of cash flow needed to fund your lifestyle without the need for significant asset liquidation, at least for the first few years?
I don’t know about you, but performing these three exercises leaves me apprehensive and depressed. You and I both desire is a long, active and carefree retirement without concern over paying for life’s basic necessities. Why is it that only 5% of us will accomplish this reality? There are four good reasons:
- We turn responsibility for retirement portfolio management over to someone else. A Wall Street fund manager doesn’t know you or your family. You are one among thousands, even millions! That guy at his desk in New York couldn’t care less about your risks, goals and ambitions for the retirement years.
- The bulk of 401(k) and IRA savings are dumped into common stock mutual funds which are high risk and very volatile. For a long time now, US stocks have been in a secular bear market with little if any inflation-adjusted appreciation since the year 2000. Worse yet, let’s suppose you had retired in 2009 and needed immediately to liquidate some or all of your 401(k) stock portfolio. How about a return of $ .40 for every $1.00 you had invested over the years? With our country’s fledgling recovery and balooning federal deficit, it could happen again!
- Because of excessive fees, your 401(k) investment money is playing against “house odds.” Financilal institutions and Wall Street Fund Managers siphon off $1.3 trillion a year in management fees–and it’s all 100% legal! The Fund Managers get paid whether or not they beat the market. It’s like the Las Vegas slots: you win some, you lose some but in the end the house comes out ahead. Not very sound odds if you’re counting on asset appreciation for retirement.
- Even should your portfolio appreciate, funding of retirement is about size and reliability of annual cash flows, not asset valuation. Your goal is a sound, reliable cash-generating nest egg, both early and late in retirement. In today’s low interest rate environment, it becomes increasingly difficult to generate sufficient income without unacceptable risk taking. Although certain stocks generate decent dividend returns, it makes no sense to count on traditional stock-based 401(k) plans to generate the annual cash flow you will need.
Don’t fret: for those of us at middle age, there may be a better way. In my next blog, I’ll describe some non-traditional pre-retirement investments which guarantee tax-advantaged annual appreciation and generate certain cash flow for a pre-determined number of years. I’ll also summarize “risk management” tools which can protect you against the financial risk of a major health crisis or your need for extended care. For additional advice right away, tune in to the Feruary 5, 2013 broadcast of my weekly Internet radio proram, “Middle Age Can Be Your Best Age” at www.WebTalkRadio.net.