Will your retirement money last as long as you do?
That’s the essential financial planning question for those approaching retirement. And there is no easy, one-size-fits-all formula to make planning easy.
In fact, most of those traditional “easy answers” have been thrown out by sophisticated financial planners. The old saying that your percentage in stocks should be the inverse of your age would leave a retiree with a 35 percent exposure to the stock market at age 65. Depending on circumstances, that could be too risky or too conservative.
The Hidden Risk in Target Date Funds
Target date funds attempted to find a solution to this issue of stock market exposure as an investor ages. In fact, they have become a “safe harbor” choice in 401(k) plans, with more than $1.5 trillion invested in them. Target date funds slowly reduce equity (stock) exposure as a worker reaches retirement age. It’s called a “glide path.”
Still, most target date funds leave people highly invested in stocks — and exposed to stock market risk — in the years approaching retirement and even after retirement.
While stocks outperform over the long run, those who must withdraw funds for retirement expenses would be highly compromised by a bear market at the start of their retirement. In financial planning, that’s called “the risk of sequence of returns.”
One target-date fund company has come out with a warning that most target date funds are no place for pre-retirees to hide. Ron Surz, president of Target Date Solutions, an advisory firm, advocates a V-shaped glide path for target-date funds. It would bring stock market exposure down to 10 percent in the five years before and after retirement, sharply reducing portfolio risk in these most vulnerable years.
Surz has created his own target date fund index. He is urging the industry to use it and adapt their target date glide paths before a highly-invested generation finds its retirement plans decimated by a market decline.
But don’t wait till your target date fund changes its allocation. You can use this kind of thinking to revise your own retirement planning.
The Simple Approach to Equity Risk
Michael Falk is a CFA, adviser to investment firms, and a sort of “renaissance man” for strategic investment thinking. I highly recommend his latest book “Let’s All Learn How to Fish … to Sustain Long-Term Economic Growth,” a thoughtful and entertaining approach to curing the ills of our financial system, from Social Security to economic growth.
Falk says the “conservative period” of a high cash allocation should really extend as long as 10 years before and five years after retirement to mitigate the potential impact of a bear market on your retirement plans. If this sounds too conservative and something you’ve never heard, just remember that most advisers do not get paid advisory fees on cash and cash equivalents in your account!
Falk offers three strategies for pre-retirees:
—Immunize your spending needs. Falk says you need to figure out your basic spending needs and compare to your guaranteed income, such as Social Security and a pension. You may also want to purchase an immediate annuity with a portion of your retirement savings or consider a reverse mortgage. Once guaranteed income covers basic living expenses, you can look at investment risk differently.
—Understand the personal impact of losses. Falk notes that $100 per month saved vs. a 10 percent loss on an account value of $1,000 is recovered in just one month. But if the account value was $100,000, the recovery of $10,000 (a 10% loss) will take years of new savings or time for the market to bounce-back.
—Invest holistically. Falk understands human nature. He advises younger savers: “Don’t ‘leverage’ anything until you get at least a proper emergency fund set up so that any likelihood of forced sales is very low.”
Yes, over the long run, the stock market provides superior returns. But first you must ask yourself just how long your “run” is likely to be! And that’s The Savage Truth.