5 Ways to Fix Your Retirement
06/29/2012 9:00 am EST
Many of us worry about Social Security and our 401(k)s, but there’s no one grand retirement crisis; we each have our own. Here are five crises that may sound familiar, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.
There is no grand, overarching, systemic retirement crisis.
But that’s actually bad news. Because instead of one grand crisis—for which we might find one grand solution—there are at least five separate crises, and each demands its own solution.
You know about the retirement crisis—no matter what your situation. Even ostriches with their heads buried in the sand have seen the headlines saying:
- that Social Security won’t be around when they retire
- that city or state pensions will be cut (if they don’t go broke altogether)
- that rising inflation will eat up retirement incomes
- that bond prices will fall
- that stock market returns will be significantly lower than they have been in past decades
- or that financial market volatility will produce a decade of buying high and selling low that devastates portfolios
You’re almost certainly aware, too, of the causes: an aging world, massive overspending by governments (and individuals); inefficient capital allocations that have lowered future global returns; massive undersaving by governments (and individuals), a worldwide festival of deleveraging as everyone from the guy down the block to the government of Greece has to spend less in order to pay off debt; the odds of rising inflation….
And you’ve read the solutions, perhaps passed them around dinner table with friends or awakened sweating in the middle of night after a nightmare in which you’re trying to sell everything you own at a yard sale and nobody is buying. But the likelihood is that you’ve wondered if those solutions really apply to you.
- Yes, the federal government can fix Social Security—at least for a couple of decades—by raising the income ceiling on Social Security taxes. But does that "fix" mean you can stop worrying?
- Yes, you’ve said (jokingly) that your retirement plan is to work until you die. But do you really think that will be necessary or possible?
- Yes, you’re sure that your 401(k) is doing fine—but you haven’t been able to bring yourself to open your statements for almost a year now.
The truth is that those common solutions don’t necessarily apply to you. Our own individual and very specific financial situations determine how the retirement crisis affects us to such a degree that those differing financial circumstances effectively make this common retirement crisis different for each of us.
The retirement crisis means very different things to a 65-year old who has saved diligently but is seeing the income from a retirement portfolio fall; a 45-year-old who is wondering how to put enough money away for retirement when the definition of "enough" seems so fluid; and a 25-year-old who is, justifiably, so cynical about all the accepted wisdom that saving anything at all seems for saps.
Ideally, I’d describe the individual retirement crisis that faces each of us. But because I don’t know the financial situation of each of my readers—and because I am constrained for space even on the Internet—I’m instead going to break down the retirement crisis into five pieces.
Call them The Five Stages of Retirement Grief. I’ll try to describe each one and then suggest some approaches to individual solutions:
Crisis No. 1: Shrinkage
The problem: You’re retired or on the verge of retirement and you’ve done everything right. You drew up a financial plan and saved diligently. But your plan has run into a shrinkage problem. The 5% or 7% or whatever return you assumed just doesn’t look like it is going to be there in the future.
Certainly, you weren’t planning for three-month Treasury bills to be paying you 0.08%, or ten-year Treasuries 1.61%. And you’re worried by projections that say the real return on stocks going forward is going to be more like 5% (if we’re lucky) than the 7.5% real return that has been the assumption of choice recently. (That assumption replaced the 10% assumption that was the common wisdom in the years before the 2000 bear market.)
And the rate of return you’ll actually get makes a huge difference. At 7.5%, a $2 million retirement portfolio throws off an annual $150,000 in income. At 5%, the annual cash falls to $100,000. At 4%, it’s $80,000.
Crisis No. 2: Whoops
The problem: You haven’t been quite as diligent as you should have been, and now you’re on the verge of retirement. When you crank the numbers, they just don’t add up.
That $750,000 you were supposed to have looks more like $400,000, thanks to recent bear markets and higher-than-expected college expenses because Johnny didn’t get that lacrosse scholarship but decided to go to Johns Hopkins anyway. (Of course, you could have said no.)
You’ve been through your budget, and even when you take into account lower expenses since the kids will be out of the house (you really, really hope) and you and your life partner will be able to cut out all those work expenses, it looks as if you’ll have a tough time making ends meet.
Crisis No. 3: Too Much
The problem: You’re a long way from retirement, you’ve done your homework, and you know not only that you should save and invest but even how much. But, while you’re putting something away, it’s not as much as it should be.
There’s the money that has to go into the kids’ college funds—because you know they’ll be behind a very big eight-ball if they don’t go to college. (And then there’s all the money that you are tempted to spend on tutors and lessons and the like so they can get into the best college possible.)
The health insurance at your job isn’t as good as it once was, and it costs more. The lower prices at Costco (COST) and Family Dollar (FDO) sure help with the family budget, but gas to drive there isn’t cheap and the car is getting on in years.
The car isn’t the only thing that’s aging, of course, and you worry about paying for the gym and health care. The family needs all its workers to stay healthy enough to work for a good long time.
Crisis No. 4: Damn the Financial Markets
The problem: Your plan for a comfortable retirement might have worked, except that you ran into the bear markets of 2000 to 2002 and 2007 to 2009 in stocks.
Now you’re worried that the stock market is going to deliver a replay in 2012. And you worry that the bond market looks set for a long period of falling prices and climbing yields as the world gets back to normal, assuming that it does. All this has played havoc with your financial plans.
The stock options from your job weren’t ever going to turn you into Google’s (GOOG) Sergey Brin, but they sure would have made a solid contribution to retirement—except that they expired worthless in 2001. That commodity exchange traded fund was a great idea in 2007, but it was a disaster in 2008 (and the volatility in early 2009 was just too much to bear, so you sold).
And now you just can’t seem to find your footing in this market. Put money in what looks like a sector trending strongly upward, and the entire market heads down, taking your investments with it. Nothing that you thought that you knew about investing seems to work the way it’s supposed to.
Crisis No. 5: It Seems Pointless to Try
The problem: You’re 25 or 30. You’ve got a job, although you don’t know how long it will last, and it would sure be great if it came with health insurance.
You’re making enough now to put something away. Looking around, though, it’s hard to see where or why. The stock market is one idea—until you think about how scary stocks have been over the past decade, which is pretty much your whole adult life.
Should you buy a house? That’s how your parents’ generation (or was that your grandparents’?) built wealth. But you know a lot of people who paid more for their houses two or three years ago than they’re worth now.
Put your money in a savings account or a certificate of deposit? What’s the point? You know all the arguments for saving and investing instead of spending, but there’s just no positive reinforcement for that these days, with interest rates so low.
Are there solutions that will help with these problems and these five different crises? Sure. And while the exact mix of elements that you would find most valuable in building a solution will vary with your crisis and problem, the elements themselves form a relatively limited collection.
Solution No. 1
You can always live on less—although I’ll bet that wasn’t what you were looking forward to during what were once called your golden years.
But a crisis isn’t exactly designed to respect your preferences, and hey, if the problem is that you need to replace capital that you’ve lost or to compensate for capital you didn’t save earlier, putting some creative thought into reducing your spending is a very good investment.
Solution No. 2
You can plan to work longer, although hopefully not until you fall over. The key word is "plan."
The economy hasn’t gotten any friendlier to older workers just because it’s become more hostile to younger ones. Companies would still prefer to replace higher-paid older workers with younger workers, turn higher-paid older employees into lower-paid contract workers, or, best of all, turn higher-paid older employees into lower-paid younger contract workers.
My point is that you cannot assume, given demographic trends, that there will be an available job for as long as you want to work. So if working longer is a major part of your retirement plan, you’re going to have to invest something in making sure you can find a decent job when you need it.
That investment doesn’t have to be money spent on taking courses. Instead it can be a second job that pays you while you build new skills, or that lets you create a broader track record of accomplishment.
This is the economy that the smartest 28-year-olds that I know assume is normal. Nobody in that age group assumes that a job will last, or that today’s skills will be enough for tomorrow. Second jobs, volunteer work, freelance gigs—all these are part of the mix.
(And, of course, don’t forget that your health is the biggest single factor in your retirement plan. A good part of your health as you age is determined by the luck and genes, but you can do things to tilt the odds in your favor. Those things are a good investment in your retirement.)
Solution No. 3
Look to increase the returns from your portfolio. Part of this is what we at Jubak Asset Management call searching for "smart beta" investments.
Not all parts of the financial markets go up together. What you want to do is be in those sections that are going up when they’re going up.
This doesn’t mean aggressively daytrading or eschewing long-term investing. In fact, a smart beta investment can be a bet on a long-term trend placed when that trend is still taking shape and the stocks you use to play it are cheap and out of favor.
You buy luxury retailers when everyone hates them—like now—and you don’t chase the low-end retailers that everyone currently loves. You ease your way into oil and energy stocks when they’re out of favor—maybe not quite yet, but soon—because you know that this sector swings from gloom to boom.
You know that someday the Eurozone crisis will have receded far enough so that stocks from faster-growing emerging markets will beat the performance of slower-growing developed markets. You buy gold when inflation is hardly a glimmer in anyone’s eye.
Solution No. 4
Look to increase the returns from your portfolio using what we at Jubak Asset Management call "smart alpha" investments. If a smart beta investment goes up because you’re in the right market at the right time, a smart alpha investment goes up because a manager or strategy has added return above that of the market return.
I think (and hope) that my strong-currency dividend portfolio will wind up being a smart alpha strategy. Getting above-market performance out of that portfolio depends on selecting the right currencies and the right high-dividend stocks to represent those currencies.
Smart alpha investments are hard to find, and they almost have to involve relatively small parts of the market because they often try to exploit market inefficiencies that can be bid out of existence if too much money is thrown at them.
(I’m part of a group that is building an Internet marketplace for smart alpha and beta investments. When it’s up and running in August, my readers will get an invitation to join for free. Watch this space.)
Solution No. 5
Look to reduce your risk by selectively diversifying into non-correlated investments, ones that will go up when other investments in your portfolio go down.
Often the "increase your returns" advice that I gave in Solutions Nos. 3 and 4 involves taking on extra risk. To offset that, what you’d like to find are non-correlated investments.
In the best of all worlds, of course, all these investments will go up, just at different rates and with different timing. In some markets, it’s hard to find non-correlated investments—and, unfortunately, we’re living through exactly that sort of market.
Stocks in almost all the world’s markets are dancing to the tune of the Eurozone debt crisis and fears over slowdowns in China and the United States. Because of the nature of this market, one of the hottest investment trends right now is the search for alternative investments that will provide high positive returns, but that don’t move in lockstep with the big stock and bond trends.
Gold is working that way right now. So, on many days, is the Japanese stock market. Stocks of US homebuilders are correlated with the US stock market, but they have behaved in a non-correlated fashion to the euro crisis recently.
Needless to say, finding true alternatives is hard—harder than most of the marketers of alternative investments will admit. I’m scouring the bushes right now for true alternatives. When I find them, I’ll write about them here.
(The smart alpha and beta Internet marketplace we’re building will include alternative and non-correlated investments. Your invitation to that market will give you access to educational posts and investment offerings in those categories, too.)
Necessary, But Not Easy
If all this sounds like a lot of work, it is. You don’t navigate a crisis—whether it’s the euro crisis or the retirement crisis—by setting your investment portfolio on cruise control.
I’d like to tell you that I see a return to the days of 1990s when a rising tide lifted all boats, but I just don’t see a return to that soon. Things aren’t as simple as they once were—if they ever really were.