When market volatility is up, people tend to focus on their asset allocation decisions. They talk to their friends, they read up on different types of financial planning, and they often come across “retirement rules of thumb” that will surely be the answer to their portfolio problems.
Let’s take a look at some of these so-called rules.
Rule No. 1, “The percentage of stock in your portfolio should equal 100 minus your age.” That would mean a 40-year-old investor would have 40% of his money in bonds or fixed investments and 60% in stocks. Most 40-year-old investors are in a position where Social Security benefits may not be a guarantee. Most know they will have to work at least until age 67, if they want full benefits. If you were to have 40% of your investable assets in bonds, you could be missing out on higher returns.
As a general rule, we recommend having only money you need within the next 10 years in fixed income investments, while money you do not need in the next 10 years should be invested in high-quality common stocks. If you know you are working until age 67, you, ideally, want to get as much growth from your investments as you can. With interest rates at all-time lows, stocks are generally your best option for growth.
Likewise, you could be 80 years old and have $2 million in investable assets, but only spend $30,000 a year. It wouldn’t make sense to have 80% in bonds earning minimal interest.
Rule No. 1 does not take into account an investor’s current assets or how much they should need of those assets in retirement. Nor does it consider other sources of retirement income, such as, pensions income, Social Security, etc. To us, this is clearly not a one-size-fits-all financial planning strategy.
To borrow a phrase…this retirement rule is busted.
Rule No. 2, “Save 10% of your pay for retirement.” If you are always saving 10%, the amount you save each year will increase with your pay. It sounds good, but to us, this rule still fails on many levels. It fails to take into consideration, your age, what your spending needs might be in the future, and it fails to consider when you start saving and how long you have until you want to retire.
Saving a portion of your income is always a good habit, but the amount you save really depends on how much you need and how long you have to let those savings grow. As a basic illustration, consider saving $5,000 a year beginning at age 20. By age 60, assuming a 10% growth rate, you would have $2,434,259. Now if you waited until you were 40 to begin saving, you would have to save $38,637 a year to have that same $2,434,259 by age 60. That is no easy feat, and for many, impossible to do.
In our eyes, saving 10% of your pay for retirement is a good stepping stone, but by no means a solution. Again, we say, “retirement rule busted.”
Moving on to rule of thumb No. 3, “You need 70% of your preretirement income during retirement.” Let’s say you make $100,000, annually. According to this rule, you should only need $70,000 per year in retirement. This rule does not consider your retirement goals. If you were fortunate enough to be able to retire early, but you choose to spend your golden years traveling, your spending need could very likely increase.
To determine how much you need in retirement, you need to closely look at what you spend and what you might want to spend. While you may reduce your need to pay transportation costs like tolls, parking garages and gas when you stop working, you may decide to fly across country more often to visit your grandchildren. While you may no longer need to buy work clothes, you may find yourself buying more golf accessories.
Health care costs are another often overlooked expense you may have in retirement. Again, if you are fortunate enough to retire early, you will have to pick up the cost of your health care coverage until you are eligible for Medicare. Once you are enrolled in Medicare, you still have co-pays and prescription drug coverage to consider.
Our experience with clients is that very rarely does spending decrease in retirement. So if you were retiring because your investments allowed you to live on 70% of your current income, you may be surprised to find out that isn’t enough. Retirement rule of thumb, busted.
Rule No. 4, “It’s best to convert your traditional IRA to a Roth IRA.” While a down market is often the time to convert an IRA to a Roth because less taxes should be due on the conversion, converting isn’t always the best choice. You should consider your current tax bracket and your possible future tax brackets. Of course, future taxes are a very big unknown. You also should look at the growth rate assumed for the Roth IRA investments, and how quickly you can overcome the cost of paying taxes now on the conversion.
Of course, if you were to convert, and the market were to continue to drop, causing the value of your Roth IRA to decline, you have until October 15thof the following year to recharacterize the conversion. This date is the date to file your previous year’s taxes, plus the six-month extension. For federal income tax purposes a recharacterization treats the account as if the conversion never happened.
While converting might work for some, it may not work for everyone. Everyone has unique circumstances that make these decisions very personal to the investor; therefore, this retirement rule is…let’s say plausible.
At Henssler Financial we believe you should Live Ready, which includes understanding that retirement rules of thumb were designed to be generalities that do not take into account your unique financial circumstances. Financial planning should not be a cookie-cutter formula, but should account for all the variables in your life that might influence how your money is spent. If you have questions regarding your financial plan, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
