I was going through my magazines the other day, and one little graphic jumped out at me. It showed the results of a survey of working 56-65 year-olds who were asked about their retirement plans. What it told me was that there are still a lot of misconceptions out there on how to plan, save and invest for the future.
The mainstream press doesn't do much to shatter these myths. So I'm going to go point-by-point through the survey results, and I hope I'll be able to set many people straight.
Finding: 43% of those surveyed believe they'll be able to withdraw 10% or more of retirement savings each year without exhausting their capital.
Reality: The widely accepted "safe" withdrawal rate is more like 4%-5% per year from a well-diversified portfolio of stocks and bonds, according to several studies. As with most of investing, the term "safe withdrawal rate" comes with a disclaimer: 4%-5% is merely a figure based on historical data that provides a high probability you won't outlive your money.
How can that number be so low if the stock market, on average, returns 10.4% a year? It's because the 4%-5% figure takes into account the fluctuations of the stock market as well as inflation -- an often overlooked piece of the retirement income puzzle. First, the "safe" withdrawal rate assumes you aren't 100% invested in stocks; you have at least some assets in bonds and cash, which carry lower returns. Second, the average market return is an oversimplification of how the market really works. If the S&P 500 is up 10% one year and down 10% the next, the "average" return is 0, but you would end up with less money. Third, you have to take into account inflation. If you assume that the historical rate of inflation is 3.5% per year, your portfolio's returns have to grow that much just to keep up, and your withdrawals have to increase at the same rate so you don't lose purchasing power.
This is why I say that you have to target double-digit returns with your investments.* To be able to withdraw 4% a year, keep up with inflation (3.5%) and pay your taxes (assuming a 25% bracket), you'll need to aim for at least 10% a year -- more if you want to withdraw more, if inflation is higher than 3.5%, or you're in a higher tax bracket. I wrote an article on bonds a while back that explained the math behind this statement.
Remember, this is a target of at least 10% so you can potentially withdraw 4% a year. Most retirement portfolios aren't set up to target double-digit returns, which means withdrawing 10% is well beyond a pipe dream for most people.
Finding: 49% of those surveyed believe their income needs will drop by half after they retire.
Reality: I meet with retired clients all the time to go over their financial situations. Rarely do I see cases where their spending has declined in retirement. In fact, the opposite is true more often than not -- they typically spend more!
That's just from personal experience, but academics are finding similar results. Researchers at the University of Michigan found that in the aggregate, pre-retirement spending and post-retirement spending are about the same. Other studies suggest that spending initially goes up in retirement and doesn't begin to decline below pre-retirement levels until the retiree gets much older.
Although your job-related expenses may decrease and you may have paid off your mortgage, you have to take into account other expenses such as travel and healthcare. The cost of healthcare, and the cost of healthcare insurance, is rising at twice the rate of inflation.
Finding: 38% of those surveyed believe that long-term care is covered either by health insurance, Medicare or disability insurance.
Reality: Medicare covers few long-term care services, and people must meet strict income and asset requirements to qualify for Medicaid. Health insurance and disability insurance generally doesn't cover the cost of long-term care. And those costs can be huge.
A private room in a nursing home today costs about $70,000 a year. Since 1990, the price has been increasing at an average of 5.8% a year. If you have enough millions in the bank to cover these kinds of costs, you probably don't need long-term care insurance. For everyone else, it's a different story.
Finding: 60% of those surveyed believe that at age 65 they will have a 25% chance or less of living beyond age 85.
Reality: The odds are more like 50%, and the expected joint life expectancy of a healthy 65-year-old couple is 30 years. That means there's a good chance that one member of the couple will live to age 95. Which brings us to the next point…
Finding: 56% of those surveyed say the greatest financial risk for retirees is longevity risk.
Reality: I'm glad to see they got this one right. But it tells me that a large number of people aren't connecting the dots: They think they can withdraw 10% or more per year and have much lower expenses, but they're still worried about outliving their money. They don't seem to realize how one affects the other.
But you aren't like that now, are you? You now know that to successfully make it through your golden years, you need to save prodigiously and invest wisely. And you need to plan. If you feel you're already on the right path, then congratulations! If not, it may not be too late. Email me or give me a call at 214-245-5236, and perhaps we can work together to get you back on track.
1. "Taking a pass on financial reality," Investment News, 30 June, 2008.
2. Bengen, William P. "Determining Withdrawal Rates Using Historical Data," FPA Journal, [accessed 21 July 2008].
3. Cooley, Philip L., Carl M. Hubbard and Daniel T. Walz. "Retirement Savings: Choosing a Withdrawal Rate That is Sustainable," AAII Journal, February 1998, Volume XX, No. 2, [accessed 21 July 2008].
4. Easterling, Ed. "Waiting For Average," Crestmont Research, [accessed 21 July 2008]
5. Hurd, Michael D. and Susann Rohwedder. "Changes in Consumption and Activities at Retirement," Michigan Retirement Research Center Research Brief, July 2005, [accessed 22 July 2008].
6. "Facts on Health Care Costs" (National Coalition on Health Care, 2007) [accessed 22 July 2008]
7. "The Importance of Personal Financial Protection" (American Society of Pension Professionals & Actuaries, 2006),[accessed 22 July 2008]
*Double-digit returns is an objective, not a guarantee
Kim Snider is the President and Founder of Snider Advisors, an investment adviser registered with the SEC, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.
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