Four Major Pitfalls of Investing in
Retirement
Investing in retirement can be tricky, as it requires that
you consider several factors of lesser concern to younger
investors. Make a mistake and you could find yourself surviving
on less income than you planned, paying more in taxes, or
leaving a much smaller legacy to your heirs than you thought
you would.
Planning for the right time horizon
It seems weird to consider longevity a risk, but when it
comes to living out your retirement with enough money to do
what you want, take care of medical costs and even keep a
roof over your head, the longer you live, the more likely
you are to have trouble keeping up.
Whether or not you realize it, longevity is the number one
risk facing retirees. Your life expectancy if you are now
65 is at least 20 years, but that represents an average; many
seniors live much longer. In fact, a 65-year old male has
a 25 percent chance of living past 92, a female has a 25 percent
chance of living past 94. Thus that 20-year number isn’t
very useful when it comes to individual planning.
Living beyond your expectations, then finding yourself modifying
your lifestyle downward towards the end of your lifetime could
be a nightmare.
Market Risks
Retirees still need to invest a portion of their nest egg
for growth, yet cannot afford to take on the same level of
risks as a younger person because there is less time to make
up for bad decisions that have a negative impact on your portfolio.
If you use static, average rate of return when planning for
how long your savings will last you don’t allow for
the reality that average is just that, some years are going
to be better and some worse. If low or negative return years
occur in the early years of retirement, the damage to your
portfolio may significantly impact your future income projections.
Inflation
Most investors do not realize that your income must double
every 20 years just to keep up with the average rate of inflation.
Many pensions do not include a cost of living adjustment,
thus your personal savings will have to either grow adequately
to cover inflation, or be large enough to allow you to draw
an ever-increasing amount of income each year.
Starting retirement with too large a draw down
As discussed above, the amount of income you need to draw
from your savings, just to maintain your lifestyle will increase
with time. Other costs such as medical expenses are also
likely to rise, as you grow older.
It can be difficult to really envision what your life will
be like in 20, 25, 30 or more years, and for that reason many
retirees begin retirement taking too large a percentage of
their savings. Sometimes the reason appears to make sense,
“my portfolio gave me 6 percent this year so I’ll
take 5 percent and leave the rest to grow,” unfortunately
this line of logic doesn’t take into account market
fluctuations that may cause next year to deliver no income,
or perhaps you receive income, but your principal is reduced
leaving less money to grow and keep up with inflation.
A study done by three professors at Trinity University examined
this issue using historical rates of return and portfolios
that were configured with different stock/bond ratios, to
reflect varying returns and volatility. The study is too complicated to go into
detail here, but it clearly suggests that the longer you plan
to be in retirement, the lower your initial draw down rate
must be.
Most retirees will need to start somewhere in the 3-6 percent
range, then allow increases to that amount for inflation.
Figuring out what you should take will require analysis of
your life expectancy, the number of guaranteed/lifetime income
sources you have (such as pensions or annuities), and the
composition of your portfolio.
In conclusion, when it comes to developing your financial
plan for your retirement plans you need to pay close attention
to details that were less important when you were younger.
Fortunately it is possible to structure most portfolios to
protect yourself from running out of money.
Your best defense is to sit down with a retirement income
planning specialist who can address your specific needs, concerns
and desires, and help to develop a plan and portfolio that
will allow you to sleep comfortably in the knowledge that
your life will remain financially secure.
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