The cartoon shows a man sitting at his kitchen table, coffee cup in hand, looking over his retirement statement. The caption reads: "According to your latest figures, if you retire today, you could live very, very comfortably until 2:00 p.m. tomorrow." Accumulating enough money for a comfortable retirement doesn't happen by accident. And procrastination carries a heavy cost. On the other hand, developing a realistic long-term plan that takes into account your financial needs and personal goals provides tremendous benefits.
For most of us, the likelihood of enjoying our preferred life-style during retirement is heavily dependent on steps we take years before we move into that season of life. The following three financial steps are among the most important you can take before reaching retirement to help guarantee that your retirement life-style will meet your expectations.
1. Be completely debt-free at your target retirement age. This includes your home mortgage and any college debt you may have incurred for your children. Debt, especially a high mortgage payment, limits investment options and life-style flexibility. If you need to add additional principle to today's monthly mortgage payment to pay it off by retirement, do it!
2. Maximize your contributions to your company's retirement plan, such as a 401(k). Hopefully you realize that Social Security will not meet 100% of your retirement needs. Public policy continues to move towards individuals becoming increasingly more responsible for funding their own retirement. The tax-deferred investment growth and savings discipline that occurs inside your company's retirement plan is hard to beat. Contributing to an IRA is also a good idea, especially if you're already taking full advantage of any matching within your company retirement plan.
3. Establish a savings/emergency fund. In other words, build your personal liquidity. Why is this important? First, it buys you time. Personal savings will allow you to postpone tapping into your retirement savings for monthly living expenses after the paychecks stop coming in. You will have adequate time to reposition your retirement investment assets, if necessary, and let them continue to grow tax-free. Second, it provides efficiency. If you need $20,000 for a new car, you won't have to take $30,000 out of your retirement funds, pay $10,000 in income taxes, and then have $20,000 left to spend for a car. Again, this allows your long-term investments to continue growing tax-deferred.
A "Total Return" Approach
"How am I going to replace that monthly paycheck?" is frequently the first question a newly retired person has. But, is it the right question to ask first? We believe it's merely one of a series of questions that, correctly answered, lead to good investment decisions. Instead of focusing immediately on income, a more appropriate starting point is determining which is a greater concern to you ? the short-term risk of market volatility and potentially losing principal in the short run, or losing purchasing power to inflation over your retirement lifetime?
If you're uncomfortable with the idea of ever losing any money, then fixed-income investments (e.g., bank certificates of deposits, money market funds, Treasury bills and notes, short-term bonds) are the most appropriate investment vehicles for you. However, people are retiring earlier and living longer, and all but the very wealthy need to continue to invest some money in stocks in order to keep up with inflation.
A retired investor has to weigh the importance of two competing desires. One is the desire to minimize portfolio volatility and not lose money, even over short time periods. If this is a major priority and you have a sufficiently large retirement nest egg, you can stick with income-oriented strategies and enjoy very little short-term volatility.
But for many, the more pertinent concern is not running out of money during your (or your spouse's) lifetime. If you're not likely to retire with enough money to simply "live off the interest," this means constructing a retirement portfolio that will grow with inflation and protect your purchasing power and life-style. That means continuing to invest a significant portion of your portfolio in stocks. But aren't stocks risky? The traditional answer is "yes." Stocks generally are more volatile than bonds. But because of inflation, volatility isn't the whole picture on risk.
