Cover Story: Retirement Guide: Introduction
HOW TO RETIRE
Strategies for retiring LATER, investing SMARTER, and living a more ACTIVE lifestyle
Retirement isn't what it used to be. For decades, working people aspired to put in their time on the job, then head off to a life of leisure. That's changing--and in a big way. Americans are living longer and staying healthier. As a result, during the past five years, they have stretched their working lives--after decades of earlier and earlier retirement.
With 77 million baby boomers approaching their golden years, this is only the start. A new BUSINESS WEEK/Harris Poll shows that 75% of relatively well-to-do baby boomers expect to keep working after they retire from their current careers (page 88). That decision requires new planning. In our 1998 Guide to Retirement, we give you strategies you'll need.
A new approach to financial planning is crucial. In the past, you've been told as you approach age 65 to skew your asset mix away from stocks and toward bonds and other, more conservative, investments. But now, there's an excellent chance you'll live at least 20 years past the traditional retirement age, so you can take more risk to beat inflation and live comfortably (page 76).
If you would rather not figure out the proper asset-allocation mix yourself, a new type of time-targeted mutual fund can do it for you. You pick a portfolio that corresponds to your projected retirement year, and as the date approaches, the investment mix becomes less risky (page 86). To quell the fear of outliving your savings, you can turn to several income-producing strategies (page 80). They could be especially useful if the stock market cools off as retiring boomers start cashing in their stocks a few years down the road (page 92).
There's more to retirement than tending your nest egg. You may want to stay employed--not just out of necessity, but because you enjoy holding a job, want to combat boredom, or have a yen for a second career (page 108). To augment your professional life or satisfy a longtime yearning, perhaps you'd like to finish college or get a PhD (page 106). In addition to pursuing a second career, you might want to use your life skills helping others as a volunteer in a school for troubled teens or clinic for indigent patients (page 110). Former President Jimmy Carter has found fulfillment in volunteerism around the world--and took a little time off to explain what it means to him (page 112).
An active retirement can mean travel. But forget the tour bus. A number of travel companies sponsor trips to exotic locales that cater to seniors with a penchant for adventure (page 102). And one of the big decisions is whether to move to a new place. A condo on the golf course may not be the ticket. How about keeping busy in a bustling college town (page 98)? Of course, you'll have to stay in shape. That's where joining a sports team or club of like-minded athletes can make staying healthy fun (page 104).
Even if fitness is your goal, you still may need a little help from technology as your eyesight or dexterity wanes. Fortunately, devices such as programmable hearing aids and software that turns computer print into speech can make life easier (page 96). And don't forget that more and more online resources are becoming available (page 94).
There's no question that retirement can open up a new and satisfying world. "Many people are no longer willing to walk out the office door and just play golf," says Stephen P. Barnes, head of Barnes Investment Advisory in Phoenix. An active retirement can really become the best years of your life.By Toddi Gutner in New YorkReturn to top
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THE NEW MATH OF RETIREMENT
Many tried-and-true formulas may not apply when you live--and work--longer
"Retirement is very different than it was even 15 years ago. It is becoming a transition state, not an end to itself." -- Ross Levin, president of Accredited Investors Inc., an Edina (Minn.) financial consultant
Whether your retirement goal is money or fulfillment, surveys suggest that most baby boomers now want to work during their golden years. This transformation of retirement from kick-back-at-60 to a more active period of life can give you a new degree of flexibility in planning your financial future.
Working longer can allow your retirement portfolio to expand by compounding for a greater period of time. Starting a second career, shifting to part-time work, or joining the staff of a nonprofit organization can also let you take more investment risks--and potentially get greater returns--as long as you continue to earn a current income. But the passing of the classic retirement pattern is making long-term savings and investment planning a lot more challenging.
If you're planning a partial or late retirement, what's the right asset mix for you? It may not be the tried-and-true formula your broker, accountant, or financial planner dishes out. "People should not put too much faith in the standard rules of thumb when it comes to asset allocation," says Henry T.C. Hu, banking and finance law professor at the University of Texas Law School in Austin. "You need to think, `How does a mix of investments fit into my particular situation?"'
Indeed, many common investment guidelines are misleading in the new world of retirement. For example, one maxim says to subtract your age from 100 to figure out the right percentage of equities in your retirement portfolio. If you're 55, that would mean 45% equity and 55% fixed income. But that simple rule takes only your age into account. It doesn't include your willingness to weather swings in the market, let alone whether you currently enjoy job security, are about to go through your third corporate downsizing, or plan to continue working well into your 70s.
Or how about the common wisdom of putting most of your money into fixed-income securities at retirement? Sure, that will give you more current income to live on, but you may be shortchanging yourself. "With life expectancy increasing, equities may play a bigger role in retirement to protect you against inflation and to provide asset growth," says Michael T. Daley, a senior vice-president at CIGNA Corp.SOPHISTICATED AIDS. These questions shouldn't leave you in despair. Despite the hours people spend picking mutual funds and figuring out the market's every twist, economic research suggests that asset allocation will be the main determinant of your portfolio's long-term performance. Fortunately, the task of creating an optimal asset allocation for yourself has been made easier with sophisticated computer software and Web sites (table). And many companies are offering employees a new generation of retirement financial planning models as part of their benefits packages.
To give you a head start, we turned to Financial Engines Inc., a Palo Alto (Calif.) advisory firm founded by William F. Sharpe, the Stanford University economist and Nobel laureate (page 78). Using complex mathematical models, Financial Engines has prepared some asset allocation strategies that estimate how postponing retirement and adopting more aggressive savings and investment techniques could fatten your portfolio--and what the risks are of doing so.
You can't get rid of some uncertainties. Who knows what such things as investment returns and tax and inflation rates will be when you start drawing down your savings? "There's a risk you won't reach your goal, no matter how good a saver you are," says Robert J. Garner, national director of Ernst & Young's personal finance consulting practice. But it's crucial to try to bullet-proof your portfolio as much as possible. "As long as you develop a reasonable understanding of the trade-off between risk and return," says Sharpe, "you'll probably do O.K."
One thing you'll see immediately from running various asset allocation scenarios is how staying active longer can make a big difference to your savings. Let's take a median U.S. household in its 50s--call them the Smiths. After accounting for their debts, they have accumulated a net wealth of $325,000, including pensions, Social Security, and housing. Economists James Moore and Olivia S. Mitchell of the Wharton School estimate the Smiths will have $380,000 by the time they hit 62. To maintain pre-retirement consumption levels if they retire at 62, the Smiths will need to start saving an additional 16% of their annual earnings right now. By delaying retirement three years to age 65, however, the Smiths' nest egg will swell to $420,000 and the required additional savings will drop to 7% of their annual income.
Now let's take another example: a risk-averse 50-year-old earning $100,000 a year who we'll call Jim. He is putting 10% of his salary into a 401(k) plan, currently worth $600,000. Financial Engines estimates that if he puts two-thirds of his money into bonds and one-third into equities, he'll have only a 34% chance of reaching his retirement goal: an annual income of $80,000 a year, figuring retirement at 65. If Jim waits until he's 70 to retire, however, he'll have a 75% probability of hitting that $80,000 goal. Jim could further stack the odds in his favor by saving more every year or by putting some money into risker--but potentially more remunerative--investments, such as growth stocks and international equities.
Indeed, the essence of asset allocation is the balance between risk and expected return. For example, from 1970 to 1997, 30-day Treasury bills--the classic risk-free investment--returned an average of 6.8% annually. But the value of T-bills fluctuated, on average, by only 2.7% a year. By contrast, stocks have offered the highest potential returns, but also greater risks. Over the 27-year period, the Standard & Poor's 500-stock index had an average annual return of 13%, with its value swinging up and down an average of 16%. But after 16 years of a bull market and recent returns closer to 20% or 30%, "people seem to be making the assumption that stocks aren't that risky anymore," says Mark Motzel, manager of asset allocation at American Express. Stanley E. Hargrave, principal owner of IMS/CPAs & Associates in Riverside, Calif., puts it another way: "Someday, these high rates of return have got to come down."
That's why it pays to heed the age-old mantra of spreading your assets among equities, bonds, and other assets to diversify risk. And recalibrate your asset allocation as time passes and your needs or risk tolerance change. "Most people haven't looked at their allocation at all," says Martin L. Leibowitz, chief investment officer of Teachers Insurance & Annuity Assn.-College Retirement Equities Fund. "They've let it drift with the markets."DANGEROUS MISTAKE. Another mistake you may be making is not "looking at your portfolio as a whole," notes Meir Statman, a finance professor at California's Santa Clara University. You may have segregated your assets by purpose--retirement, college, and so forth. "This kind of `mental accounting' is dangerous to your financial health," warns Sharpe. Why? Let's say you've saved $100,000 in your college account. Your child is going off to college in five years, and you have divvied up the portfolio into 20% equity and 80% fixed income. You also have $100,000 in a retirement account, split into 75% equities and 25% bonds. While the allocation in each account sounds about right, your overall asset mix is 52% fixed income and 48% equity. That may be too conservative. You might be better off with a 60-40 mix of stocks and bonds, so "any short-term shortfalls can be offset with long-term gains," says Jeffrey Schwartz, principal at Ibbotson Associates in Chicago.
To get the most from your investments, focus on understanding your risks and time horizon, and then decide how much to put into stocks, bonds, cash, and so forth. Use computer or Web programs to play with "what if" scenarios as you come up with the right asset mix, or interview several financial advisers if you're not up to the task of allocating assets on your own. Then, parcel out your assets into taxable and tax-deferred accounts. For example, you wouldn't want to put tax-exempt municipal bonds into a tax-sheltered IRA. The IRA would be a more proper home for an equity-income fund whose dividends you want to shelter from taxes. A Roth IRA, which permits tax-free withdrawals if you're at least 59 1/2 and have held your account for at least five years, is especially attractive.
Investment doesn't just mean long-term savings. In the New Economy, human capital--brains, skill, and energy--is increasingly valuable. The returns of education show up in higher wages and greater job security, so learning new skills and keeping current with advances in your profession is another way of reducing risk through diversification. "There is an argument for thinking of human capital, and not just stocks and bonds, as an asset class," says Massachusetts Institute of Technology economist Andrew Lo.
However you view asset classes, you need to develop an allocation plan before you retire. Planning during your pre-retirement years and following smart money-management principles will give you greater odds of having a comfortable income when you finally decide to relax.By Christopher Farrell in St. Paul, Minn.Return to top