Retirement Investing: Forget 4%

Do you want to reduce your standard of living when you retire? Of course not. But if you follow conventional financial planning ‘wisdom’ concerning retirement investing, that’s exactly what you may have to do! Whether you are currently retired or wanting to in the next 5 to 10 years, you must take action now to protect your lifestyle dreams. It’s your retirement. And if you rely on the retirement investing advice you get from the vast majority of brokers, insurance agents and advisors you can kiss your dreams good-bye. You must take responsibility and control of your situation. Rest assured, though, the solution is common sense.

When it comes to retirement investing, the financial services industry says two things. First, that the most effective strategy is to take no more than 4% out of your nest egg each year. So to avoid tapping into your principal and to protect yourself from inflation you have to earn 6-7% a year.

Second, their wisdom says that in order to reduce your risk of loss you must shift an increasing percentage of your portfolio out of stocks and into bonds as you near retirement. Of course, that’s the only way they have of reducing risk…but more on that later.

Several factors make their strategy doomed for failure. Retirees are living longer and better than ever before. Retirees in their 70’s are still very active and on the go. More are living into their 90’s and even 100’s. This is good news for seniors, but it places a much greater burden on their financial assets.

These increased life spans and active lifestyles also correspond with a reduced savings rate. Put bluntly, today’s retirees are entering their golden years with smaller nest eggs than their parents had. This is due in part to the end of an era when you could spend decades working for one company and retire with a comfortable pension. Today’s retirees are more dependent on their own contributions into and management of their 401(k).

A quick look at the numbers shows how much times have changed. A couple of decades ago, $40,000 a year would allow a retiree to live comfortably. With a life expectancy in the mid-70’s, one would only need about $550,000 to provide that.

Even if you were able to live on that same $40,000 today (good luck!), almost $800,000 will be needed to sustain you into your 90’s. And the percentage of people living into their 90’s is quickly growing. That’s a 45% increase in the size of the next egg needed.

Moreover, that assumes you use all your principal—leaving no cushion for emergencies or inheritance for your children. And it doesn’t take into account inflation. Realistically, you need your income to increase each year. If you want to maintain $40,000 worth of purchasing power and not touch the principal, you would have to have $1,000,000 AND increase your rate-of-return to 6.5%.

I bring all this up to show that it is imperative that you earn a higher return on your money both leading up to retirement and throughout retirement. Increasing your return during retirement to just 8% a year drops the amount needed in your nest egg from $1,000,000 to around $615,000. In other words, the ability to average 8% a year will allow you to retire many, many years earlier.

The conventional wisdom of shifting your portfolio into bonds is equally dangerous. If you have 50% of your portfolio in safe government bonds earning 4.75% you must earn 11.25% on the rest of the portfolio to average 8% a year. In other words, the more you reduce your risk by investing in ‘safe’ bonds, the greater the strain you put on the rest of your portfolio.

I don’t know about you, but I don’t want to base my ability to live comfortably during retirement on the ability to earn over 11% a year on stocks. But if you listen to the financial services industry that is the gamble you are taking.

It doesn’t have to be that way. In the next article, I will reveal the strategies and techniques that break with conventional wisdom, but that may allow you to live a more comfortable retirement.

Are you in need of some financial advice? I’ll personally respond to your questions, free of charge. Go to http://www.guardingyourwealth.com and click on ‘Ask Jeff’.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.