Many Americans are nearing retirement age or even starting retirement. While there are many notable exceptions, as a generation Baby Boomers have made great incomes during their careers but have not saved enough for retirement. Many plan to work longer or really never stop working. Unfortunately, there is not always a choice as many are finding themselves laid off in their late fifties or early sixties.
Note that retirement is a relatively new issue since, with a life expectancy of 67 years, many in past generations died soon after stopping work. Some individuals are also finding the need to return to work after a short retirement. Such is the case for a former Oral-B vice president. Despite a six figure income during his working career, he had only $90,000 at retirement. His nest egg was not able to weather the 2008 financial crisis, forcing him to return to work.
So how can one prepare to weather a long retirement? The secret is a combination of a large amount of savings and investments and a reduction in liabilities.
Your Savings. Because you’ll have no source of income beyond your investments (including pensions), you’ll need to keep more cash on hand than you did while you were working. When you had a paycheck coming in your could afford to wait when the market swooned. In retirement, you’ll still have bills to pay regardless of how the market is doing. For this reason you’ll need to keep a savings of at least 3-5 year’s worth of expenses in liquid assets such as bank CDs and money market funds, preferably spread out among a couple of banks. These can be structured with a few month’s worth of savings in a money market fund, another years worth of savings in a 6 month CD, and then the rest in a one year CD (or even a longer term CD for some of the funds).
If you have income producing assets, such as bonds or dividend paying stocks, these can be used to rebuild your savings. Bonds typically pay interest payments twice per year, while stocks pay dividends quarterly. These payments can be directed into a money market fund and either be used to purchase CDs as income builds or to refill short-term savings, allowing the longer term CDs to be rolled over as they mature. In an ideal situation there would be plenty of income from bonds and income stocks to pay for all regular expenses.
Your Investments. You cannot afford to take the risks you took when you were younger with your investments. A big loss now may never be regained. The rule therefore is diversification. In addition to having a generous portion of income producing assets, you’ll need to have your stock investments spread out among a wide array of assets. This means having mutual funds invested in different segments of the market (large caps, small caps, and international). You also might wish to have some real estate exposure, either directly with rental properties or through REITs.
Your tolerance for having investments in individual stocks depends on the size of your portfolio. If you only have 5-10 times your needed annual income saved, individual stocks might be too risky. If you have 20 times your income saved, you have more latitude since you’ll be able to wait for your portfolio to recover.
In fact, the more money you have saved and invested, the less cash you’ll need to keep on hand and the more risk you can take. Even if you suffer a rather large loss in percentage terms, if you have a large nest egg you’ll still have plenty of money to meet expenses. The ability to take on extra risk translates into more retirement income. While this advice won’t help you much if you’re 59 with retirement around the corner, think about investing more for retirement if you’re in your twenties.
Your Expenses. Lower expenses translate into a lower required income. All loans should be paid off long before you’re entering retirement. (Ideally they would be paid off before your kids are ready to enter college.) You should think about downsizing your home to lower maintenance and air conditioning costs. Moving to areas with a lower cost of living is also a consideration.
Realize that you will see expenses that you didn’t have earlier in your life. You’ll likely be taking different prescriptions and seeing the doctor more regularly. This may very well eliminate much of the savings you have from not having a mortgage bill. Remember to budget this in when determining your income needs.
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.