Retirement: Reality or Mirage? Challenges in a changing world
By Tony Allison, June 23, 2008
Baby Boomers, and even succeeding generations, need to be looking at their retirement years with eyes wide open. In a rapidly changing world, “hoping for the best” is not a viable strategy. For millions of unprepared Americans, retirement may prove to be more mirage than reality. The following is one of a continuing series of retirement-themed essays outlining potential risks to avoid and necessary preparation for a successful retirement.
Risks to a stress-free retirement
There are many risks lurking in the weeds to derail one’s retirement dreams. There have always been risks of course, but today’s global economy pushes the risks to a higher level. The US is no longer the world’s economic giant, dominating global commerce. Retirees in 1960 were cushioned by low inflation, generous company pensions, inexpensive health care, and the backing of a country that was a net creditor, energy self-sufficient and unchallenged in industrial and technological might. None of these “security blanket” elements exist for today’s retirees and many government promises of future benefits may prove more rhetorical than real.
One of the most basic risks to retirement is just not putting enough wealth away during one’s working years. Many people have 401k’s and IRA’s, but don’t fund them every year, or carefully monitor the investment performance. With the major indexes flat (or worse) this decade, many 401k’s have shown little if any growth. In addition, many investors make the mistake of leaving most of their 401k savings in their own company stock. In these turbulent times, betting on the success of any one company is taking a big risk with your retirement savings.
Unfortunately, many other Americans have never started retirement accounts at all, and with inflation gnawing at the dollar’s purchasing power, find it difficult to put any money away for the future. In addition, those who assumed the equity in their homes would fund their retirement are seeing that dream severely tested.
This goes along with under-saving, but includes other aspects of retirement. For those close to retirement, this would include preparing a budget to get a realistic picture of expenses now and what they may look like in retirement. Without a clear understanding of both essential and discretionary expenses, it is impossible to know if one’s retirement income will be sufficient to fund the desired lifestyle. We all have caviar dreams, but none of us want to end up eating Alpo to get by.
Many pre-retirees may fail to prepare because of an “expected” inheritance. However, circumstances can change over time, and the size of that inheritance may shrink substantially. In addition, the potential for higher estate taxes in the future could devour large chunks of a substantial inheritance.
Preparation would also include looking into downsizing into a smaller house or moving to a more tax-friendly state. It is also important to have access to health and medical facilities if you plan to relocate.
The risk of higher taxes, while uncertain, is overwhelmingly likely in the decades ahead. The demographic reality of 79 million retiring Boomers will, without doubt, put a tremendous strain on the government to provide Medicare and Social Security benefits. The $60+ trillion in unfunded future liabilities will very likely lead to higher income and payroll taxes, as well as lower benefits and means-testing. In addition, our growing $9 trillion national debt will keep compounding, and our massive trade deficit, much of which is imported oil, will need to be financed (currently $2 billion per day, every day, from foreign sources). Unless the government simply prints the money and destroys the value of the dollar, then higher taxes (of all shapes and sizes) will be a reality for future retirees. The biggest danger is we may see both realities. The third option would be for government spending to be radically cut in future decades. As long as retirees can vote, don’t expect that to happen.
Health Care Costs
The explosive rise in health care costs does not seem likely to ebb as the aging Boomer generation floods into the health care system in future decades. This is one of the most difficult categories to predict for most retirees. It is safe to say most will not have budgeted enough for future health care costs, including long-term care. The shrinking dollar carries much of the blame.
This may be the biggest risk of all and one that affects all the other categories. Inflation acts as an invisible tax and can destroy the dreams and lifestyle of any retiree that is not adequately prepared for it. Earlier generations were fortunate not to be subjected to high rates of inflation for prolonged periods. Current retirees may not be so fortunate. The combination of massive federal, state and personal debt, fewer productive workers, and (since 1971), a purely fiat currency leads one to believe that inflation will be a painful reality for future retirees. It is imperative that strategies for future inflation be part of the retirement planning process.
This will be a huge societal issue for the Boomers and those generations to follow. Current advances in medicine, health-care, and improved lifestyle habits are already leading to huge leaps in longevity. The Baby Boomers will, as usual, take longevity to new levels, with hundreds of thousands (or more) expected to live to 100 and beyond. This new reality means retirees must seriously consider living nearly as long in retirement as working, and how to make the money last. Going back to work at 94 is not an appealing proposition.
In 1900, 1 in 25 Americans was over 65 years old. The vast majority was self-supporting or supported by their family. By 2040 it is estimated that one out of every 4 to 5 Americans will be over 65. This vast majority will be supported by the government to some degree. According to the Concord Coalition, by the mid 2020’s America will be as old as Florida is today. Imagine seeing more people pushing walkers than baby strollers.
Debt, in moderation, can be beneficial during one’s working years. However, dragging a large debt load into retirement is a major concern. It is true that future debt payments will be made with inflated dollars, but debt also compounds and can wreak havoc on a fixed income. Clearly it would be best to pay down one’s debt load as much as possible while still working. The government can simply print more money to pay its debts. The retiree should not try this at home. It is entirely plausible that many Boomers will delay long-planned retirement due to the albatross of high personal debt.
Role of Bonds
Fixed income has been the traditional investment of choice for retirees. While bonds still have a role to play in a retirement portfolio, it should be a lesser role if you believe that significant inflation will be a reality during the retirement years. Moreover, in a study published in the October 2007 issue of the Journal of Financial Planning, two college professors, John Spitzer and Sandeep Singh, argue that retirees should spend their bonds first, gradually lowering the fixed income allocation. Their contention is the greater the exposure to equities, the less likely a retiree will exhaust his savings.
Most retirees would be uncomfortable without any fixed income. One strategy suggested by Professor Spitzer would be to retain 20-30% of one’s portfolio in short term bonds to use during times when the stock market is weak. When the stock market is strong, equities could be sold and more bonds could be purchased. This of course is a direct challenge to the “target-date” funds that automatically lower the equity allocation as one approaches retirement. It is impossible to predict the perfect allocation years from now, but my concern is that retirees will invest just like their parents or grandparents did in 1960.
Role of Stocks
Equities obviously can play a significant role in funding a successful retirement. The key of course is diversifying among many companies, and buying successful companies with established track records for growing earnings and paying dividends. The role of dividends will become ever more significant in future decades as retiring Boomers seek income and inflation protection. Owning a company that pays a dividend that grows and compounds every year is one of the few ways to protect one’s purchasing power in retirement. There will likely be hundreds of new mutual funds catering to this niche in the future. Many of these funds will hold companies from Asia, Europe and around the globe. The hunt for growth and dividends will be a global phenomenon.
Role of Diversification
If possible, retirees should be diversified among their assets, including stocks, bonds and real estate. They should also seek some currency diversification as well. If all one’s assets were denominated in US dollars and the dollar continually loses value, then purchasing power is lost. Examples of diversification out of the dollar could be investing in tangible assets, and foreign stocks, bonds or real estate.
Role of Flexibility
It is important to stay flexible and involved in one’s retirement planning, even years into retirement. The traditional “ratios” may not apply in 10 or 15 years from now. Planning to live on 75% of your working income may not cut it if inflation hits 10% for an extended period of time. Even 5% inflation can be devastating to quality of life unless you plan for inflation and hedge against it. Even if you haven’t planned for it, there are ways to mitigate the inflation if you are flexible enough to take action. But just staying put in fixed income bond funds as your standard of living implodes is not a recipe for a happy retirement.
The world is a very different place than it was in 1960, or even 1990. This doesn’t mean one can’t enjoy a long and fulfilling retirement in the 21st century. However, for most of us it does mean more diligence, preparation and discipline is going to be required. Every journey begins with the first step. If you are not already on the journey, it would be wise to start walking now.
Stocks stalled Monday, ending mostly lower after rising oil prices and ongoing worries about the financial sector gave investors little reason to buy a day ahead of a Federal Reserve meeting.
The Dow Jones Industrial Average was down .33 to close at 11842.36. The S&P 500 Index was also flat, closing up .07 at 1,318.00. The Nasdaq however was lower, ending at 2,385.74, down 20.35.
Disappointment that Saudi Arabia is not boosting production by more than 200,000 barrels a day sent oil prices higher, fanning concerns about inflation. Light, sweet crude rose $1.38 to settle at $136.74 per barrel on the New York Mercantile Exchange.
Gold tumbled nearly 3 percent in volatile trade on Monday, ending just above $880 an ounce as a sudden rise in the dollar against the euro prompted panic selling by funds in exchange for cash.
Wishing you a good evening,
© 2008 Tony Allsion