What is the life expectancy of an American today who is age 70? Did you know that it is now 97.4 years of age using a blended table of male/female life expectancies? And, in the future, we can expect to live even longer! Will your retirement assets still be “alive” at that age?
When we first begin working with the vast majority of business owners and professionals, they will outlive their assets. Their portfolios and planning are simply not sufficient to last over time. This lack of understanding of the expanded life expectancy, and how long their assets must sustain them, has me deeply concerned.
From my years of experience in helping clients plan for the future, I routinely see twelve pitfalls and traps that can keep them from achieving their retirement dreams. So … let’s get started!
No review process
- No review process. A very common and fixable mistake is not scheduling a periodic review of your written retirement plan. We frequently review portfolios with clients on a quarterly basis. At least annually, you should review where you are at concerning your accumulation of assets, your projected values, and the income necessary to meet your objectives.
You should perform this review with an outside party who is professionally trained in the growing sub-specialty of retirement planning. Most investment advisors have only been trained in “accumulation planning,” and not in the “decumulation planning” process which individuals experience when they retire. To fill in this knowledge gap, there are two noteworthy designations that require an in-depth study of retirement issues: the “Retirement Income Certified Professional” (RICP) and the “Chartered Retirement Planning Counselor” (CRPC).
In my RICP course studies, I have learned that the four most “dangerous” years are the two years just prior to retiring and the first two years after retirement. It is critically important to make sure that you are actively reviewing your planning just prior to retirement and just after you retire. If the economy has a significant adjustment as occurred in 2008 and 2009, your assumptions may be completely “out-of-whack.” Use a review to compare the actual performance of your retirement investments with your objectives. “Stress test” the portfolio. How does it stack up using a 1% lower return? A 2% lower return? And, in this review, be sure to also look at the effects of inflation, lifestyle changes, family needs and potential changes in the success of your business.
Lack of diversification/Non-correlated assets
- Lack of diversification/Non-correlated assets. A lack of diversification is often the result of missing entire “asset classes” or having certain asset classes over or under-weighted in your retirement investment portfolio. While there is some disagreement as to what exactly is an asset class (for example, intellectual property–including patents, trademarks, and copyrights–has been listed as an asset class in one portfolio seen), for most investors, there are five primary categories into which most of their money should be invested.
The five primary types of investment classes are:
- Cash and its equivalent (e.g., treasury bills, notes, money market funds, or FDIC insured bank deposits),
- Fixed income investments (e.g., fixed annuities, high grade government, corporate or municipal bonds),
- Ownership in publicly-traded businesses (e.g., domestic and international stocks in outright ownership or through indexes or Exchange Traded Funds),
- Real estate (apartments, offices, storage units, industrial warehouses, through either direct ownership or indirect ownership through Real Estate Investment Trusts, syndications, partnerships, etc.), and
- Commodities (productive farm land, oil, minerals, timber, water rights, mines, precious metals, such as gold or platinum, etc.)
Each asset class has its own benefits and drawbacks. The specific asset allocation of your portfolio will depend on a number of factors, including your “risk tolerance,” timelines, needs, and resources.
You can reduce the overall risk in an investment portfolio by selecting several different non-correlated assets. The amount of correlation ranges from -100% to 100% and is based upon historical returns. A correlation of 60% between two stocks, for example, means that when the return on one stock was going up, about 60% of the time the return on the other stock was also going up. A correlation of -50% tells you that 50% of the time they were moving in opposite directions—one stock goes up while the other goes down.
By mixing in ownership of non-correlated assets into your portfolio, you are better prepared to “survive” the fluctuations in the market–also called “volatility”—and the ups and downs in your overall portfolio values. Holding only one asset class will bring the greatest volatility. Mixing in other asset classes, with the differing lengths of “financial cycles,” will reduce the degree of volatility and actually improve returns over time.
- Underperforming assets. Underperforming assets may be difficult to review on your own but you can research how other similarly situated investments have performed. I would recommend, however, that you have a financial advisor review your investments to determine if your investments are performing as well as other benchmark investments.
Underperforming assets usually fall into three different camps:
- First, the asset may be poorly chosen based upon your risk tolerance. If this is your situation, then you should consider replacing it with an investment that more closely aligns with your risk tolerance levels. (There are a number of tools which can assess your level of risk tolerance. They help determine the appropriateness of certain investments to you, and/or the percentage of your portfolio that should be invested in various asset classes.)
- Second, the poor performance may be based on “cookie cutter” investment strategies that are overly generic and not specialized to your situation. Often there is a lack of meaningful diversification and in the long run, bring greater volatility risk and lower performance returns to a portfolio.
- The last reason is that even if you have large gains in your investment, excessive advisory or load expenses can consume these potential gains and leave you with underperforming returns.
No Investment Policy Statement
- No Investment Policy Statement. A great way to avoid the first three retirement pitfalls discussed above is to have an “Investment Policy Statement” (IPS). I seldom find one in place for individuals, and even rarely for a business or non-profit organization. Creating an IPS with your advisor puts your investment strategies and rules in writing and is like having guard rails on a bridge. It keeps you in your lane, and protects you from making an ill-advised turn that could land you “in the creek without a paddle.”
In addition, one of the frequent mistakes I see is when investors “fall in love” with their investment. They keep it when they should consider “taking some profits off the table,” or diversifying their holdings. Or, investors sell an asset when the investment is doing poorly and buy new investments when the price is at a premium. The goal should be to “buy low and sell high” and this can only be accomplished when you are not overly attached to any particular investment. Having an IPS helps you to stick with your original investment plan and not deviate due to market conditions and emotions.
At a minimum, the IPS should outline:
- The objectives (e.g., purpose, goals, timelines),
- Investment philosophy (e.g., trading frequency, costs, your risk tolerance profile),
- Investment selection criteria (e.g., whether you will purchase individual stocks or only mutual funds),
- Asset allocation, and
- Periodic review (e.g., how often will you review your investments? How much of a deviation from your target asset allocation is okay before you rebalance your investments?)
- Psychological reasons. There are many psychological reasons why people put off retirement planning. See if you are using any of these common reasons:
- Fear of future events. Fear can keep you from doing what you know needs to be done. Your fear(s) may be of running out of money, becoming sick, being less active, losing a life partner or family member, feeling financially inept, etc. The list is endless. A “deer in the headlights” mentality is often the case when people feel overwhelmed or when they are unsure of whom to trust. (By the way, fear can be thought of as, “False Evidence Appearing R”)
- Your self-worth is tied up with working. What you do is a substitute for who you are. Your success in business reinforces your ego and provides the various “toys” by which you measure your “success in life.”
- Work is a “mistress.” Work fills a psychic need for relationships but without the “complications” that come from human interaction or a committed relationship.
- You don’t know what you’ll do when you retire and have all of that “free time.” An over-commitment of work hours leaves little time to develop social connections and a convenient excuse as to why you cannot participate in activities outside of work.
- You think you are too busy to begin your retirement planning at this moment. You continue to delay the process with the hope that you will not be as busy sometime soon in the future. Unfortunately, a more convenient time never arrives.
- All of your time, attention and energy are focused on immediate concerns. You have not reserved any time to do any long-term planning for your retirement.
Lack of immediacy
- Lack of immediacy. Unfortunately, many people do not understand the importance of beginning their retirement accumulation planning as soon as possible. Often, people think that by putting off the investment for another year, they are only losing out on that year’s contribution. But, in reality, they fail to recognize that they also lose a year of compounding interest.
Losing a year of interest on your retirement investments may not sound like a big deal but it can, in fact, be an even greater loss than the initial contribution itself. Because of the extraordinary benefit of compound interest, waiting one year may make a difference of tens of thousands of dollars in accumulation in certain cases … just waiting a single year! The only way to recoup those lost earnings would be to make riskier investments, which could, in turn, cause you to fall even further behind. The best time to save for retirement is right now, no matter what your personality traits are or where you are situated in your career, and no matter how small the amount. Start putting money away now! Create a “positive addiction” towards accumulating money for “future delivery.”
Lack of specifics
- Lack of specifics. Many people do not have a written retirement plan in place. And, even worse, they have not even attempted to calculate how much they will need in retirement. According to the 2016 Retirement Confidence Survey by the Employee Benefit Research Institute, only 48 percent of people have even attempted to calculate how much they will need for retirement.
If you do not have a written retirement plan, then all you have are some vague notions about your retirement. Think of your retirement plan as a roadmap that can be used to plan for the future. It helps to clarify any uncertain goals that you may have and gets you started on actively taking action to make your retirement goals a reality.
For those clients who do have a written retirement plan, it often lacks specifics such as dates and financial data. For example, some questions that require answers are:
- What amount of income will you need to live a comfortable retirement? How much in savings and other assets will you need to acquire?
- What rate of inflation do you want to assume? (The average has been 3.22% from 1913 until 2013. Since 1990, however, it has been 3% or less.)
- What amount of Social Security and pension benefits can you expect to receive? (We use a sophisticated computer program to run various scenarios to help you determine the best age to begin taking Social Security benefits.)
- What are your expected expenses, including health care costs?
- What are the expected rates of return on your investments? (Returns are often lower after you retire … as retirees are much less likely to stomach volatility in their portfolio.)
- At what age do you (and your partner) intend to retire, and will you retire fully or will you continue to work part-time? (40+% of retirees state they were forced to retire before they wished –so understand that retirement may not be your choice, but a life event for your company, or you or another family member that is out of your control.)
- How long do you (and your partner) expect to live? (According to the Uniform Lifetime Table, the blended life expectancy for an IRA owner is 27.4 years if you are age 70! Will your money last that long?)
Excess current consumption
- Excess current consumption. A consumptive lifestyle will frequently derail your ability to save for retirement. The desire to “keep up with the Joneses.” The “need” to live in a luxurious home, have vacation property and timeshares, drive upscale vehicles, send your children to expensive schools and spend without regard to your budget (if there is one) on clothing, jewelry, dining, vacations, etc. Do you feel you deserve a reward for all of the hard work you have put in, and for the accomplishments you have already achieved?
All these material items can bring some temporary comfort, but what if they keep you from ever being able to retire? “Delayed gratification” is a concept rather “un-American.” Still, being able to retire “as planned,” often means making sacrifices now. Make your calculations (or meet with us and we’ll do it together)–save what is indicated is required–and you will reap the rewards by being able to comfortably retire some day short of 1,000 years from now.
Misconception of longevity
- Misconception of longevity. Statistics indicate that we are likely to live far longer than we ever could have imagined. According to the Uniform Lifetime Table, the blended life expectancy for an IRA owner is 22.9 years if you are age 75. Will your money last that long? And remember, at age 97.9, half are expected to live longer! Will that be you?
A longer life expectancy means that you will have more expenses to deal with over the course of your lengthy retirement years. Will you draw down on all of your retirement and pension accounts too soon and be left with nothing but Social Security benefits to live on?
Relying too heavily upon Social Security or other assets
- Relying too heavily upon Social Security or other assets. Assuming that Social Security will be fully funded and able to pay you a monthly payment each month may be wishful thinking. The federal government has borrowed all of the money that was in the Social Security Trust Fund; thus, there is no guarantee that Social Security benefits will be paid out for all of your retirement years. The baby boomers are beginning to retire, which will commence a huge increase in Social Security payments each month for this 18-year bump in the population.
Relying on the sale of your business or other assets is a pitfall that can have dramatic repercussions. What if the business or assets you are relying on lose all or a significant amount of its/their fair market value? What do you do then? One way to minimize such a devastating loss is to insure against all or a portion of the risk of loss.
Thinking that you can continue to work indefinitely
- Thinking that you can continue to work indefinitely. We often take our health for granted and think that we will be able to continue to work indefinitely. Not only does this misconception concern our own health, but also the health of our spouse and other loved ones. As mentioned above, we are all living much longer lives. This fact increases the chances of having an aging or ill parent, sibling, relative, partner or child who may need your full-time care.
The Caregiving in the U.S. report, issued in 2015 by the National Alliance for Caregiving and the AARP, illuminates the growing caregiver epidemic. An estimated 43.5 million adults in the U.S. had provided unpaid care to an adult or a child in the prior 12 months. Sixty percent of the caretakers experienced a negative effect on their jobs, such as cutting back on work hours, taking a leave of absence, or receiving a warning about performance or attendance.
Job positions come to an end for an assortment of reasons, especially as you age. As an older employee, you may be phased out of your job because the employer can hire a younger employee at a lower salary. The pension benefits that an older employee earns can also be avoided by hiring a new replacement. Higher health-care costs and a shorter future with the business are also negatives for an older employee.
Ignoring tax implications
- Ignoring tax implications. If you are single and die in 2017, you will be subject to the federal estate tax if your estate is over $5.49 million ($10.98 million if married), unless you do something ahead of time. There are plenty of different ways to avoid paying the federal estate tax. One such option is to create a charitable limited liability company, which can create tax-free income streams and increase tax deductions.
Ignoring potentially higher future tax rates is another mistake that many people make. For example, consider converting some or all of your assets in your Individual Retirement Account (IRA) into a Roth IRA. Although you will have to pay federal income taxes on the conversion amount, none of the future earnings of the Roth IRA are subject to taxation as long as the money has been in the account for 5 years, you are 59 ½ years old, or you are disabled. Current tax rates are relatively modest from a historical standpoint. That alone may be reason enough to convert now rather than risk higher tax rates when you retire and start taking distributions.
Although this article is called the 12 Pitfalls & Traps That Will Keep You From Retiring Well, I’m generously throwing in another “free” pitfall and trap to make a baker’s dozen.
Ignoring Social Security
- Ignoring Social Security. Although, as discussed above, you don’t want to rely too heavily upon Social Security benefits, you also don’t want to ignore them either. What amount of Social Security benefits can you expect to receive when you retire? We use a sophisticated computer program to run various scenarios to help you determine the best age to begin taking Social Security benefits.
As you can see from all of the material above, there are plenty of pitfalls and traps that can stymie even the most well-intentioned person who wants to comfortably retire. The time to make decisions about your retirement planning is now. If you need further assistance on any of these topics, please contact me to discuss your retirement planning needs.
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Written by R. J. Kelly – January 2018