When I was still a young buck out in the workplace, financial magazines periodically published worksheets for calculating when you had enough money to retire. The process became much easier when we got our first PC. Programs like Microsoft Money had a retirement planner tab where you entered your personal data, and the program did the calculations for you.
For many years, financial planners considered four basic numbers to be conservative estimates:
- Return on your portfolio: 6%
- Inflation: 2%
- Age your money needed to last to: 120 years old
- Percentage of your portfolio to invest in the stock market: 100 minus your age at retirement
Once you stopped working, you could live off of your nest egg, plus any retirement pension, for the rest of your life. If the computer program said your money would last until your 120th birthday or longer, you were home free. The first time I plugged in my information, it said I could retire immediately - as long as I died before I turned 72. That was when we started seriously socking money away for retirement.
The final number on the list was part of a conservative investment formula. If you retired at age 65, then 65% of your nest egg went into CDs and high-quality bonds, with a locked-in 6% return. The other 35% went into the market. The formula worked well for my first few years of retirement.
That all blew up in the fall of 2008, when the first TARP bill was approved. The banks took their newfound money, paid off debt, and called in their CDs. At the time, our CDs yielded 6% on average, a rate right in line with our overall retirement plan. Today, the best rate for a five-year CD is around 1.8%.
Had we continued to follow the old paradigm and kept 65% of our portfolio in these traditionally safe investments, the income from that portion of our portfolio would have dropped by 80%. Moreover, interest rates are not budging. The Federal Reserve has made it quite clear that it intends to keep interest rates this low for years to come.
The burden of low interest is only made worse by inflation. Planning around a 2% inflation rate simply won't work anymore. Frankly, the federal government is lying to us about inflation, which is an issue I've addressed before. Shadow Government Statistics reports a current, 1990-based alternate inflation rate of just under 6%. Of over 3,000 responses to our recent inflation poll, 34% believed that inflation is 6%-8%.
You may think these figures are high, but they are much closer to reality than the government would have us think, based on the sad little 1.7% boost our Social Security checks received this year. If you're going to plan for 2% inflation, you should also plan to sell your home and move into your kid's guest bedroom, because that's where that plan will get you.
In a nutshell, since 2008 the yield and inflation estimates for retirement planning have reversed. Yields on traditionally safe investments are actually below 2%, while inflation is much closer to 6%, depending on whom we choose to believe (when in doubt, check your credit card statements).
But frankly, it is the fourth figure - "100 minus your age" - that will guarantee too many retirees run out of money much too soon. Keeping a major portion of your portfolio outside of the market in investments that do not even keep up with inflation is foolhardy. Our golden years can quickly become a nightmare of poverty if we are not careful.
The only number that still makes sense is the age your money needs to last to - 120 years old. As life expectancies increase, it's becoming more and more important to plan for a long life. But if you run out at 119, the hell with it.
Thriving under the New Retirement Paradigm
Unfortunately, the new retirement paradigm is more complicated and harder to define. Let's start with yield on your portfolio.
The government is printing money at lightning speed. The rate of inflation is increasing, turning the rate of return sufficient for retirement into a moving target best described as "enough to keep up with inflation and provide income to supplement Social Security." If it does not, you will become poorer every day, and eventually your nest egg will be gone.
How about inflation? Read inflation predictions from 10 years ago. Almost everyone said it would be around 2%. Personally, I am not a psychic; I have no prediction, only a commonsense suggestion: Err on the side of caution. If you end up with a little more money than planned, that is not a bad thing. Keep an eye on your inflation estimate, consider sources other than the Bureau of Labor and Statistics (BLS), and adjust it when necessary.
What about "about 100 minus your age?" Most savvy retirees are accepting that traditionally safe, high-interest-bearing investments have left the building and are not coming back. We must be all in to survive.
But by "all in," I do not mean all in the stock market. I would not recommend that any more than I would recommend spending your entire nest egg on an annuity or any other one investment. "Don't put all of your eggs in one basket" is a famous proverb for a reason.
By "all in," I mean fully committed to learning and understanding what options are still available for reaching your retirement objectives. This may include options like an annuity or reverse mortgage, in addition to other, more traditional investments.
And we must be all in for diversification. We cannot risk losing our nest egg once we have stopped working. That means looking for many opportunities that provide safety, yield, growth, and inflation protection.
There is no one vehicle to get the job done. It takes a combination, each contributing to your financial health in its own unique way. Dividend-paying stocks are one good example. If you own a stock paying a 3% dividend, it's not beating what I believe to be the true rate of inflation. If that stock appreciates another 6% on top of the dividend, you have inflation beat and some left over to supplement your Social Security checks, without tapping into your principal.
Hitting a Moving Target
Folks on either side of the cusp of retirement have to adapt to a changed world. We are trying to hit a moving target, but it can be done. Let's review the new benchmarks for staying on track:
- Our portfolio needs to grow at a rate sufficient to beat inflation and provide supplemental income.
- We should monitor inflation regularly. Take the BLS's official rate with a grain of salt, and consider alternative rates. Only you know your personal inflation rate, so monitor your costs from year to year and plan for increases in sectors like health care. Make sure part of your portfolio is allocated in investments that have a history of keeping up with inflation, such as precious metals.
- Plan for a long life. 120 years is still a good rule of thumb.
- Right now, I see no reason to own CDs, TIPS, or any other fixed-income investment. Their abysmal rates will destroy your portfolio. That leaves 100% of your portfolio to achieve your goal. If targets are moving, we must be able to move with them.
On a positive note, I know a good number of folks who have accumulated a decent nest egg. One old-fashioned rule of thumb that will never change is to work hard and work smart. Folks who had the skill and foresight to build a sizeable retirement portfolio have the qualities necessary to learn how to make it last. It's simply a matter of learning a new skill set.
I am reminded of the line from the old Mission Impossible television series: "This is your mission, should you choose to accept it." Baby boomers and retirees, however, have no choice. We must accept it. Now it's time to get on with the job.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.