Posts Tagged ‘Retirement’
Retirement Readjustment Needed?
An article in May’s USA Today entitled “Shrinking Nest Eggs: How the ailing economy affects yours,”[i] painted a depressing picture for those nearing or in retirement. Citing slumping housing prices, decreasing 401(k) values and rising inflation, the article tells us that many investors will be revisiting their retirement plans and possibly delaying their retirement.
The piece goes on to proclaim that “many financial analysts are predicting a prolonged period of below-average returns on both stocks and home equity.” Its author concludes that Americans may need to face a sobering fact: that many of us will have to “save more, expect less, and work longer than we planned.”
If the article’s intent was to move its readers toward a lifestyle of living below their means, then we would applaud its value as financial journalism. However, after reading a bit further, we realized that the story had less to do with falling assets and a slowing economy, and more to do with the reality that many investors misunderstand their options and make inappropriate decisions. The article referred to a few examples of people grappling with their upcoming retirements:
- A California IT worker who believes that now, after a 4% decline in her portfolio and a 25% decrease in her home’s value, she may not be able to ever retire.
- A Wisconsin comptroller for a manufacturing plant who had planned to retire at the end of this month, but who is now delaying his journey due to “the recent declines in the stock and real estate markets.”
If the investors it cited above are in any way representative of those who are currently nearing retirement, then we might make a case that the reason for their distress is not only the economy, but possibly inappropriate asset allocation, diversification and lack of appropriate financial planning.
Some financial education might go a long way in improving their outlook. Here are our planning assumptions based upon what was written:
- The California IT worker seems to have four separate items to think about:
- If a 4% decline has her worried, then she may have an inappropriate asset allocation in place and one that must not be matched perfectly to her risk capacity or tolerance.
- A 4% decrease in assets is not terribly significant over the long-term when it is related to a retirement that is more than 5 years away; we wonder what her time horizon for retirement is? It doesn’t sound like she has clearly identified the goal that she would like to hit.
- The 4% decrease has us wondering what she was investing in. A 100% all-equity/stock, high risk, investment in the S&P 500 would only have been down 2.93%[ii] over the same period.
- Finally, she is counting on her home’s equity to fund her retirement. This is speculating, not investing; it can be likened to investing in a single stock. Moreover, counting on the equity from a single property type in a single city is the definition of a concentrated investment strategy, and in this case it performed poorly.
- The Wisconsin comptroller who is now delaying retirement until 2009 must have had a volatile portfolio indeed – and one that was lacking diversification. (In fact, we cannot figure out what mix of investments would have been so volatile over the last few months as to force him to delay his retirement). Actual Total returns from January 1 to May 17 (when the article was printed) was -2.1% for the Dow Jones Industrial Average, -2.9% for the S&P 500® Index (US Large Stocks), -2.57% for the Russell 2000 Index (US Small Cap Stocks), and +1.16% for the MSCI All Country World ex US Index (International Stocks)[iii]. If he was invested in these segments as part of an overall diversified strategy then his corresponding portfolio wouldn’t have been down all that much in our opinion. Our reaction to his story was once again more philosophical in nature:
- Any investor rattled by market fluctuations should revisit his allocation policy and take some time to better understand the behavior of the equity/stock markets; this is especially true for an investor who has become this anxious after a few months of falling prices.
- Imagine for a moment that he had a very volatile portfolio had invested only in the smallest, riskiest stocks he could find and that these stocks pushed his portfolio down 10%. If he had saved up $2,000,000 that would have represented a $200,000 decrease and his portfolio would have now been worth $1,800,000 (of course, only if he sold all his investments). We are left wondering why he couldn’t retire. He must have been treading a very thin line between success and failure.
- Given that his portfolio must have been volatile enough to force a change in course for retirement, then we why he was still “swinging for the fences” and investing in such a risky manner when he was this close to his date for retirement. Good planning should have helped guide him to a less volatile portfolio on his final approach. In fact, excellent planning would have suggested that he begin preparing 2-4 years prior to avoid things like this.
- If he had consulted an advisor maybe he would have realized that he could still retire.
We don’t wish to take the above investor concerns lightly, but the ideal retirement income solution does not exist outside the limited scope of the Social Security system where the investor receives a stream of guaranteed inflation-adjusted annuity payments. As a result, many are faced with a series of confusing tradeoffs in an effort to approach similar, desired result. The examples in the USA Today offer compelling evidence that making expensive mistakes with respect to key financial decisions is all too easy.
