Retirement at Risk: Start the New Year with a Sober Assessment
By Tony Allison, January 7, 2008
At the risk of beating the proverbial dead horse, I start a fresh new year with another reminder for those within shouting distance of retirement: keep your eyes on the prize! There are many risks lurking that can negatively affect your hopes and dreams for an idyllic retirement. Even for those already in retirement, there are risks to be aware of and actions to be considered. Retirement pitfalls are a common theme these days, but for most Americans they cannot be discussed often enough or emphasized loudly enough. Unfortunately, Wall Street usually addresses the subject by showing vibrant seniors strolling hand-in-hand along deserted beaches. The (not so subtle) message: invest in our products and you too will enjoy a prosperous, stress-free retirement. This is not very helpful as an educational tool, but I’m sure the ad campaigns sell mutual funds and annuities quite nicely.
Survival Mode for many Boomers
While many Americans are in good shape for retirement, the vast majority appears woefully unprepared. And even those with millions set aside for retirement will have to deal with specific retirement risks that could derail their best-laid plans.
It is clear to most Baby Boomers that they need to save and invest more and spend less. But for many this is easier said than done. Many boomers still have children at home and elderly parents to look after. And decades of negligible real income growth have taken a toll as well. Inflation has hit hard on the middle class. The costs of health care, education, food, housing, insurance and energy have soared well beyond the growth in wages over the last decade. Many Americans approaching retirement age are living in paycheck-to-paycheck survival mode.
Future returns may differ from last 25 years
Many boomers also look at retirement planning as a boring, if not depressing, subject and as something to be ignored if possible. Those who are actively involved in investing for retirement often see the future as an extension of recent history and invest in the same manner. The past 25 years was an era of uncommon prosperity, falling interest rates and mild and short recessions. While the last quarter century featured booming stock and bond markets, it may be unwise to expect similar returns over the next 25 years. If portfolio growth expectations fall short year after year, the retirement plan begins to unravel.
The 76 million Baby Boomers, born between 1946 and 1964 represent about 28% of the population. The leading edge of those 76 million begin to retire this year. Most of them believe their Social Security, Medicare, pensions, 401-k and IRA savings will lead to a smooth transition into retirement. Others have no idea how they will retire, but figure things will work out.
Government planning sadly lacking
The government, despite what many might think, is not likely to provide comprehensive cradle-to-grave services and protection in the decades ahead. By its own admission, the Federal government has created unfunded liabilities of over $50 trillion for Medicare and Social Security, destined to rise much higher with inflation. The government has no money squirreled away. Far from it, as our current federal debt of $9 trillion continues to grow each year, not counting hundreds of billions in “off budget” items such as the Iraq war. As our population continues to age, the government will have even more difficulty expanding its tax base to pull in the necessary revenue to feed the explosive debt obligations. The Fed will likely have to create much of the money “out of thin air” and this will have predictable affects on the currency.
An economic model based on debt and consumption
As a country, we have become addicted to debt and consumption. We have gone from a country that used to save, under-consume, invest and produce, to a country with a negative savings rate. Our nation lives on infusions of foreign debt and no longer produces as much. This is an economic model without a long term future. That gets to the crux of the issue for retirees. Things may get a lot more expensive for Americans in the future.
While the government keeps deferring its mushrooming debt time-bomb to future politicians, the average person cannot defer planning for retirement until age 64. In addition to growing a sufficient nest egg during ones working years, there are specific retirement risks that need to be addressed in shaping ones portfolio both before and during retirement.
Inflation Risk- This may be the most significant risk to retirees. In the last 68 years, the CPI has gone down just twice. Don’t expect it to drop any time soon, even with manipulated CPI statistics. Expect the cost of life’s essentials, food, energy, medical care, housing etc. to keep rising. Those who plan to live on a “fixed” income may be in a real fix when their purchasing power shrinks year after year. The retirement portfolio allocation must address the very real threat of inflation.
Longevity Risk- People are living longer, through medical advancements and healthier lifestyles. The Baby Boom generation figures to set new standards for longevity, with millions living into their 90’s and beyond. Will your retirement nest egg last as long as you do? Will your quality of life die well before your heart stops beating? Longevity risk must be taken into consideration, and is closely linked to inflation risk.
Withdrawal Risk- The rate of withdrawal of retirement funds may change during retirement. A carefully planned systematic withdrawal program may run into unanticipated factors such as health problems, divorce, sharply rising inflation, rising tax rates, etc.
Allocation Risk- This is the risk of placing your savings in the wrong investment areas, and having those decisions affect your income stream or access to capital in emergencies. One example would be putting the entire nest egg in a “conservative” bond fund, only to see it decimated if inflation were to rage out of control. Another example might be having a large annuity that cannot be liquidated in an emergency.
Health Care Risk- Risks in this area are many and it is difficult to know what the future may bring. Will Medicare survive? If so, will there be means-testing? Will unforeseen health care costs be the time bomb in your retirement plans? Health care risks won’t go away. Don’t rely on Medicare to take care of all your health care needs after 65. Plan to set aside money for supplemental health care costs.
Biggest mistake- a failure to plan
A secure retirement is going to take more than hoping for the best. Perhaps the biggest mistake is the failure to plan at all. The Boomer mantra in the 1960’s was “Don’t worry about tomorrow, live for today.” That may have been cool at age 20, but it’s not so cool at 65. Inadequate planning for rising prices may be the biggest risk of all. You can’t control a pension, but you can control your portfolio.
A fixed-income only portfolio, denominated solely in US dollar assets may not be the conservative choice it was in decades past. It’s a gamble that the US dollar will not lose purchasing power at an accelerating rate. That is a gamble most retirees cannot afford to take. And with nearly a century of Federal Reserve actions behind us, the value of the dollar has only traveled in one direction; south. In addition, it’s imperative to include investments that will grow in both principal and income over time. This is the only way to stay ahead of rising prices.
Walking hand-in-hand into a beautiful sunset will depend on the choices you make before and during retirement, and your discipline to see them through. Don’t expect Uncle Sam to join you on the beach. He’ll have his hands full already.
U.S. stocks were mixed Monday, with the Nasdaq ending under 2500 at a four month low, as the equities trade fluctuated between sellers worried about the economy and buyers picking up shares on the dips in the wake of Friday's steep price drop.
The Dow Jones Industrial Average was up 27.31 to close at 12,827.49. The S&P 500 Index rose 4.55 to close at 1,416.18. The Nasdaq closed lower, ending at 2,499.46, down 5.19.
Crude oil for February delivery dropped $2.82, or nearly 3%, to finish at $95.09 a barrel on the New York Mercantile Exchange. Earlier, the contract hit an intraday low of $94.55.
Gold futures finished down Monday, as gains in the U.S. dollar and declining crude-oil prices dampened demand for the precious metal. Gold for February delivery fell $3.70 to end at $862 an ounce on the New York Mercantile Exchange.
Wishing you a good evening,
© 2008 Tony Allsion