How Retirement Works

Assessing Time, Risk, and Potential Obstacles

As you approach the retirement planning process, there are several key areas on which you will need to focus, including your time horizon (how long before you retire), level of risk tolerance, and the potential obstacles that may stand in the way of reaching your retirement goals. Each of these important factors will affect your specific retirement plan. Your personal situation needs to be considered. Remember, there are no boilerplate retirement plans.

1. Time Horizon

There are actually two areas to look at when discussing your time horizon in regard to retirement planning. First, there is the amount of time you have until you retire. This is the time frame you have to establish your retirement plan and put it into action. The more years until retirement, the more options you may have for building up your portfolio and making appropriate adjustments along the way. The second part of your time horizon is the estimated longevity of you and your spouse. While no one knows for sure what his or her life expectancy will be, there are people today living well into their 90s and even reaching 100 and beyond. Therefore, if you are eligible for an early retirement at the age of 50, you could have nearly 50 more years ahead of you. If, however, you want to keep on working until 65 or even 70, you will be planning for 20 or possibly even 30 years of retirement income. Either way, there are a number of years in which you will be receiving income from the retirement plan you set up today.

Years to Retirement. Although the concept of retirement has changed dramatically over the past 20 years, for most people, there is typically a time when they begin looking forward to calling it quits and moving on to other aspects of life, be it relaxation or starting a business. Although you may change your mind, you will typically set a target date for such a change of plans. If, for example, you are age 50 and have decided that at 62 you’d like to call it a career at your corporate position and take on a new adventure, you then have 12 years in which to prepare your finances for retirement from that phase of your life. Most people that I see come to me in their late 40s or early 50s—some even later on. Sure, they have been contributing to their 401(k) plans since they were 30, but until now, they have not really thought about their impending retirement lifestyle. And why should they? There’s no reason to be thinking of retirement when you’re 32 and busily trying to figure out how you’ll save up enough money for your six-year-old son’s college tuition. I look for the best means of building a portfolio based on the time factor involved in conjunction with each individual’s risk/tolerance factor. Typically, the closer you are to retirement, the more conservative you will want to be with their investment portfolio because there is less time to make up for any losses or downturns in the market. However, with life expectancy being what it is today, we also need to consider that you may need to generate income for a long period of time, perhaps 40 more years. Therefore, we don’t want to get too conservative. Don’t forget we also have to outpace inflation over that time as well as factor in taxes.

Longevity. The second part of time horizon, takes longevity into account. We’d all like to keep on living a good life until the age of 100. If your parents enjoyed longevity and you lead a relatively healthy lifestyle, you may also enjoy your ninetieth, ninety-fifth, or one-hundredth birthday, or even more. Certainly, the younger someone retires, the more emphasis that must be put on balancing growth (necessary to outpace inflation and taxes) and income. Here too we will look at a portfolio that addresses the postretirement time horizon. A young retiree may plan to work elsewhere for 10 or more years. If he or she continues earning an income, then we might opt to be more aggressive for a longer amount of time because the need for income from investment vehicles may not be significant for several more years. There are numerous potential scenarios, and it’s important to consider them all realistically. It is also important to prepare for unexpected obstacles that may occur.

2. Risk Tolerance

Conventional wisdom tells you that it’s prudent to invest conservatively during retirement to make your money last. But actually, the reverse is true. Once you have retired, you may need to include stocks in your portfolio to protect against outliving your assets. To plan correctly, you’ll need to decide how much income you can safely withdraw from your retirement portfolio without running the risk of depleting your assets prematurely.

One of the many questions I ask clients is, What does money mean to you? As discussed earlier, for women, I’ve found that it often means safety or security, while for men, it means power (although they don’t phrase it in that way) and, ultimately, the freedom to do whatever they want. Typically, women are more conservative and men are more aggressive by nature, and this holds true when determining risk tolerance as it relates to investing. Although this is a broad generality, it is very often the case between husbands and wives.

This approach is great for helping clients maintain their risk tolerance in a portion of their assets while taking into consideration what their long-term needs will be. In some cases, the wife may need to take on a little bit more risk in order to achieve those goals. Sometimes we need to go through an educational process to help these women feel comfortable and slowly over time invest in the market and take on an additional risk as their comfort level warrants.

The bottom line is that some people are more willing to roll the dice and take risks while others like to play it closer to the vest and opt for the conservative approach.

Your temperament and personality have evolved in such ways that you either have a strong tolerance for risk or you don’t. Perhaps you’ve been burned by bad investments in the past. Maybe you were brought up with an understanding of the need to hold onto your money closely. Or, maybe you’ve always enjoyed a little taste of adventure and have been known to throw caution to the wind, so to speak. No matter how you’ve reached your current level of risk tolerance, it will factor heavily into how you plan your retirement portfolio from an emotional standpoint.

Alternatives need to be discussed when emotionally a couple is unwilling to take on more risk in order to achieve their goals. Working longer or lowering expenses are both options that are sometimes critical to the planning process. It’s better to determine this before retiring. Any investment counselor should assess how much risk a client is comfortable taking and then work within those parameters when trying to advise him or her.

The basic principal behind risk when investing is that the more risk you take, the higher the potential rewards. Conversely, the greater the risk, the greater the volatility! The other side of the coin is taking the low-risk approach. Taking less risk usually means that the return on your investment will be less but your investment is safer. An example of a higher-risk investment would be a sector mutual fund like technology, which has great volatility. A low-risk investment would be a money market fund or a fixed income mutual fund.

Typically, the more time you have before reaching your impending goal—which in this case is retirement—the more risk you can take. Traditionally, the stock market, over time, has always proven to recover from downturns, and if you invest in the market with a long-term approach, you will make money.

While any investment will have some risk attached, the key to building your retirement portfolio will be to balance higher- and lower-risk investments in a manner that:

• Will meet your goals and retirement needs
• Allows you to feel comfortable from a risk tolerance perspective (you can sleep at night)
• Outpaces inflation and other factors that can eat away at your potential nest egg

A portfolio should balance out your level of risk by diversifying between various investment vehicles. You may, for example, have a 50-50 split between high-risk investments and low-risk investments. For the sake of comfort, or a lower tolerance for risk, you may opt for 35% high-risk investments and 65% low-risk investments. The choice should be based on guidance from your advisor in conjunction with your comfort level or tolerance for risk and both time horizons as discussed above. The idea is to put together a mixed portfolio that meets your needs. If, for example, we factor everything into account, including inflation, and come back with a 6% rate of return but the retirement lifestyle you’re seeking would need an 8% rate of return, you would either have to reduce your expectations or increase your risk.

Over the years, I have found that people who are greater risk takers as investors are also more likely to spend their money more freely. On the other hand, people who are conservative with their investments are also more conservative spenders. Typically, this works out well because more conservative investments will generate a lower rate of return, leaving the conservative spender with less money to spend anyway. I can’t recall meeting someone who wanted to invest conservatively but was aggressive when it came to spending money.

3. Potential Obstacles: Planning for The Unexpected

Potential obstacles are those issues that come up and drain away some of the funds earmarked for retirement. Taxes and inflation are two obstacles that you cannot totally avoid. We will generally factor a 3% inflation rate when preparing retirement calculations. However, it is not something that we can accurately predict. Most recently, inflation has been very low, but if you recall, in the early 1980s, we hit double-digit numbers.

The greatest potential obstacle most retirees face is whether one or both parties will need to be in some type of assisted-care facility. The question is whether they will have enough funds to support that additional cost. In some cases, there may be enough funds for one person but not enough for the surviving spouse.

Health care today is a significant concern for my clients and anyone approaching retirement. The costs are increasing, and Medicare does not help significantly; it only serves as a supplement to reduce some of the expenses. Many of my clients are leaving major corporations where they receive ongoing health benefits. There are, however, significant concerns and questions, such as:

• What can individuals do who are leaving companies that do not provide such health care?
• What happens if the company can no longer provide the health care package?
• What if the health care provided does not cover the needs of the spouse?

The ever-changing laws and the tenuous state of many companies leave soon-to-be retirees less than comfortable about their impending health care status. Therefore, this is an area we try to cover carefully while structuring a plan. Where will the money for health care, especially long-term care, come from? If there is any risk of losing those benefits, we incorporate the potential cost of health insurance in the budget so we are prepared.

Supporting Family Members. Another obstacle that has become increasingly more common has been that of supporting either parents or children. Increased life expectancy has made it more possible to retire at the age of 55 and be helping to support your mother or father who is in his or her late 70s, 80s, or 90s. This is an additional expense that you need to allocate for when planning your own retirement, particularly because many seniors did not have the savings mechanisms available 25 or 30 years ago when they planned for their own retirement needs.

The past 20 years have seen the average age of marriage slowly rise. Two careers, graduate school, and in some cases prior marriages have created family planning at a slightly later stage of life than in previous generations. Couples close to the age of 40 are more commonly having children, and in many cases, the new father is over 40. Therefore, it is not uncommon for a 62-year-old retiree to be supporting, or helping to support, his 19- or 20-year-old son or daughter while he or she attends college or embarks on postcollege life. This too precipitates a need for additional income.

To try to best accommodate the situation, you should first look at your own retirement situation without these additional costs. Next, look at the additional costs separately and determine whether you can handle them and what concessions you may need to make to do so. If you determine that you will need to pay an additional $30,000 a year for a nursing home for a parent or toward college tuition for your child, you’ll need to look at how to alter your plans. This might mean downsizing or taking on a part-time job to supplement your income. You can also work to adjust your portfolio, but this may mean having to take on greater risk to cover the additional expenses. Alternatively, you may research state nursing homes or local college alternatives or scholarships. These decisions are often very emotional and need to be made with your heart, as well as with your financial advisor.

Once you have determined your own level of risk tolerance, calculated how many years you have until retirement, and explored potential obstacles that may arise, you can begin looking at the ways and means in which you can establish, monitor, and build your retirement portfolio.