Investors who do their own financial planning often rely on industry standards or rules of thumb. Similar to those who rely on investment adages for their asset allocation, these investors are missing out on financial decisions that are tailored to their circumstances and goals.
One common thought is that your age should equal your percentage in bonds. That would mean a 30-year-old investor would have 30% of his portfolio in bonds. That could easily result in a significant amount of missed growth within a nearly 40-year investment time horizon. 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 for growth.
For example, an investor in his 80s may not need to spend all the money coming from his pensions and Social Security. For someone in that situation, we run financial plans based on the money coming in, his desired spending, along with assumptions on inflation and market growth. If the financial plans show he has no need to pull any investments from his accounts within the next 10 years, based on our philosophy, he could have 100% of his assets in growth investments. We would then have the conversation about his risk tolerance. We have had this exact situation where a client decided he wanted to continue to grow assets for his heirs. While his plan was not suitable for every 80-year-old, it was suitable for him, which is why looking at individual circumstances are so important to the financial planning process.
Early on investors often learn to “save 10% of your pay for retirement because the amount you save each year will increase with your pay.” It sounds good, but to us, this fails to take into consideration, your age, what your spending needs might be in the future, and it fails to consider when you began saving and how long you have until you want to retire.
Saving 10% of your pay for retirement is a good stepping stone, but by no means a solution. If you want to spend $60,000 after tax in retirement, and you have 10 years until retirement and there is 4% inflation, you really need $88,000 to have the same purchasing power as today. At age 65, how much money do you need to get to age 90, spending the equivalent of $60,000 after tax? If it were possible to guarantee a 10% return, you would need $1.1 million. There are no investments that can guarantee a 10% return for 35 years. Therefore, if you earn $120,000 a year, saving only 10% of your income could leave you short.
The best advice is to start saving early and often. If you can only save 3% or 5% of your income, you have to start there. As your pay increases, start saving more. If you get a 5% raise, sweep half of it into your retirement savings, allowing yourself to take home only 2.5% of your raise. Certainly, don’t make the mistake of thinking it will be easier to save for retirement in just a few years. It won’t.
Often, investors assume they will spend about 70% of their pre-retirement income during retirement. We know from experience this is rarely the case, as many factors go into determining what you’ll spend, including your retirement age, inflation, portfolio return, health, and retirement goals. If you retire early, between ages 50 and 55, you will most likely spend more than your working years simply because you will have time for the leisure activities you couldn’t do prior to retirement. 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. Retiring between ages 55 and 60, you’ll likely spend slightly more, and when retiring between ages 60 and 65, most spend close to 100% of their pre-retirement income.
A recent misconception investors have attached to are that target-date funds are a set-and-forget investment. Gaining popularity in 2007, a target-date fund’s investment mix changes as the investor gets closer to the target retirement date. An investor picks a fund that closely matches his target retirement date, for example 2035. The funds generally start aggressively invested in stocks, but as 2035 approaches, the investment mix should become more conservative. However, the funds vary greatly. Some start 100% invested in stocks and gradually become conservative. Others may start at a 75/25 stock to bond mix and change to 25/75 stocks to bonds a few years before the target date. These funds assume an investor needs a certain amount of bonds based on their age. As explained at the beginning, your bond allocation should be determined by when you need the money for your living expenses.
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:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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.
