WHAT IF YOU OUTLIVE YOUR MONEY?
By MARY LYNNE DAHL, CFP®
June 01, 2019
(SitNews) Ketchikan, Alaska - According to surveys conducted during 2018, the most common financial worry among American adults is that they might outlive their money. Financial Advisor magazine’s survey, for example, is quoted as saying that 42.66% of retired clients report that they are worried about outliving their money. This is reflected in answers to survey questions that indicate a fear of not being able to generate enough income for retirement expenses, based largely on a realization that prices are rising faster than the incomes of the retirees. It appears that many people worry that they will actually spend all of their savings and invested dollars before they die, which is a pretty grim financial situation to face. In addition, many who do not expect to actually spend all of it, still fear the continued rise in prices of ordinary things, like food and medical care, which will gradually erode their incomes until some things are no longer affordable in retirement.
The reality is that these fears are well-founded. For many people, they are true and will only get worse. Americans have simply not accumulated enough money by the time that they retire to be able to live comfortably. Too many will have to make do on Social Security alone, which typically is only enough for about 35% of the normal expenses of retirement life in the US.
Interestingly, another common worry is financially surviving a stock market crash, but few people mention that they worry about surviving a bond market crash. Keep in mind that many retirees are heavily invested in bonds by the time that they do retire. Instead of worrying about a bond market crash, people invested in bonds worry more about the low interest rates that are currently being paid by the bonds that they own. Beware however; bond markets do crash and when they do, bonds lose value just like stocks. Market crashes, however, are relatively short-lived, so surviving one takes patience to go through but does not have to totally devastate a portfolio. Few people will need to spend their entire portfolio all at once.
Over the last 35 years of giving financial advice, I have heard more than one woman tell me that she “doesn’t want to become a bag lady” in her old age, and I think a few of these women were deadly serious. I do not recall hearing this from any men, but I do know that it has been a concern of theirs as well, based on their answers to financial questions we routinely ask on paper. Both men and women have expressed that they worry about running out of money, so we know it is a common concern. It is a source of stress universally. That’s the bad news. The good news is that there are solutions.
In order to recommend solutions, it is necessary to think about the risks that are out there. Naming these risks provides us with a target to shoot at when considering solutions. These risks are often overlooked by people who will crash into them later, so let’s look at the real things you should worry about, and the solutions to each of them.
First of all, it is realistic to worry about running out of money in retirement. It is not uncommon, so you have to ask, why does this happen so often? There are several reasons that this happens.
Risk #1 is that people simply do not invest enough of their earned income while working. They save a little, spend it on stuff they want now, save a little more and ignore the fact that they should be investing for the long term. The amounts that they save are too small and the amounts that they invest are even less, if they invest at all. They therefore do not accumulate enough on which to rely for income, during their retirement years. Many working people who could participate in a company sponsored retirement plan opt-out of that plan. Those that do opt-in generally do not contribute enough and some do not even contribute enough to get the employer match (if offered), usually an additional 3% equivalent amount. This is a huge mistake, resulting in too little accumulated for retirement.
A good rule of thumb is to begin investing as early as you begin working and start by investing 6% of your earned income, then increase that until you are investing 15% - 25% of your earned income by the time you retire. That may be hard at first, but if you start and stick with it, the habit of doing this will become routine and less difficult over time. The more time you have, the easier it is, so if you are young, you have an advantage and should use it for your own future security. The solution is to start early, contribute the maximum (always). If you start late, your solution is to contribute the max to your company plan but also contribute to a separate account, as a catch-up strategy. Sorry; there is no easy fix for failing to invest enough. You have to either give up something now or give up more in retirement. Take your pick.
This brings us to Risk #2: inflation. Although we all need to have cash in savings, it is not a good strategy to try to simply save up cash for retirement. The reason is that interest is tied closely to inflation, and tends to be less than the real rate of inflation. Inflated prices of ordinary things like food, housing, insurance, education, fuel, travel and health care will rise faster than interest rates. For example, if the prices of those ordinary expenses for daily life rise by 6% but your savings only earns 3%, your dollars accumulated are worth 3% less than the goods and services that they must pay for. This is a real loss, because you really do have to spend money for food, housing etc. If it takes $1,000 today and prices continue to rise by 6% per year, in 5 years you will need $1,338 for the same goods and services. So, in order to accumulate enough for retirement, you need to grow those dollars by more than the rise in prices. Your only other alternative is to cut your spending at retirement. Unfortunately, many people are, in fact, forced to do just that….because they saved and saved, but never took the risk to actually invest. Saving money is saving, not investing. Make sure you know this and use savings for emergencies and planned purchases, not retirement. The solution to Risk #2 is to be moderate, not overly conservative and not overly aggressive. Choose investments that are good quality, use a sensible asset allocation strategy with adequate diversification among funds and stick with the plan through thick or thin. Develop the discipline yourself or hire an expert to guide you through the years.
Risk #3 is retiring too early. A solid majority of Americans take their Social Security benefits at age 62. It has become almost “normal” to do this. Sadly, this is a mistake in almost all cases. Instead, we should all plan to work at least until full retirement age, which is 66 or 67 for most people today. Better yet, work until age 70 if you are healthy.
I have written about this many times, so if you doubt the wisdom of doing this, go to the archives in Sitnews.com to review the reasons. They are solid, sensible and proven to be correct. Suffice it to say, 70 is fast becoming the new 65, largely because so many people are living much longer than in the past and leading active, busy lives that allow them to keep working. That’s great, but there is a financial reason for doing this as well. The longer you work, the bigger your Social Security benefit will be. If you wait until you are 70 to start Social Security benefits, it will be almost twice as than it would be if you begin taking it at age 62. Don’t believe me? Do the math. You will be shocked; it is clear that waiting until age 70 to start Social Security is the best option for most healthy people.
In addition, if you keep working, you can keep investing for retirement, and remember, you will have more years as a retiree than our ancestors ever dreamed of. So, you will accumulate more and probably need it. Investing while you are working is the engine that will drive that retirement train, and when combined with a larger Social Security benefit, will make a huge difference in your retired years. The solution to Risk #3 is the easiest one to perform; keep working until full retirement age at least, and do not start Social Security until then, or go to age 70 for both, if you are healthy and active.
Risk #4 is scary; it is health care costs. This includes the costs of the premiums for health care plans chosen but also includes the catastrophic costs for medical care that is not covered by the plan. In particular, catastrophic costs can occur when young, healthy persons who opt out of medical insurance or “self-insure”, experience a major accident or totally unexpected illness, causing extraordinary medical expenses. Catastrophic medical costs can also occur for older people who have really big medical bills with a co-pay or deductible requirement that is more than they can handle. A good example is medivac costs, which in Alaska can range upwards of $70,000 or more and are not included in many health care plans.
Financial experts say that some clients tend to stick their heads in the sand when this topic is discussed as part of the overall financial plan. Many deny the possibility that they could get hurt badly or sick enough to need the kind of medical care that costs hundreds of thousands of dollars.
Another major risk is long term care costs. When a client is alone, without a potential care giver to take over in the event it is needed, the only solution is to hire a caregiver. This can be very expensive and is easily one of the biggest risks facing retiring people. If you do not have a plan for getting care in place as you age, you face spending down your retirement assets rapidly in the event that you do need to pay for your care in old age.
Large medical expenses can and often do exceed the risks associated with a stock market crash, according to statics that have tracked both types of financial results over decades. Although market crashes are nerve-wracking and can do damage to any portfolio, they do end and often those portfolios recover fully over time if no action to cash them out is taken. However, medical expenses don’t evaporate or turn around like a market crash that hits bottom and turns back upwards. Medical care costs are a serious risk that demands a strategy to minimize it. Risk #4 can be solved with insurance. It may be expensive and you may be one of the lucky ones that never use it, but if you do need it (most of us will at some point) and have purchased a medical health care plan, you will not face the catastrophic losses that occur when you are uninsured and sick or injured.
Risk #5 is all too common. It is the risk that results from bad investment decisions. These decisions, as I have often stated in previous articles, happen because the individual investor is motivated by his or her emotions of fear and greed. Bad investment decisions are also sometimes the result of being too lazy to do the basic work of either getting competent, expert advice or doing your own homework if you do not get advice. Your barber, or best friend, or co-worker are not competent experts who should influence your investment choices, in spite of the stories you may hear from them, as well-meaning as they are trying to be. If you cannot do the extensive homework required to make good investment decisions, based on facts, not emotions, get expert advice. Relying on tips or gut feelings is the wrong strategy.
Relying on your emotions for investment decisions is a 2-sided coin; one side is fear and the other side is greed. Both will sabotage your retirement.
A fearful investor is overly conservative, jumps in and out of the markets when the fear factor gets too powerful to resist, goes totally to cash unnecessarily (sells all and holds the cash on the side), invests only or primarily in guaranteed investments, pays fees that are too high and unnecessary and generally avoids all market risks, except the most important one, inflation. This kind of investment mistake is an effort to never lose any invested money, even if the loss is short term and only on paper. This type of investor is very emotional and cannot cope with seeing a negative number on a statement at any time. He or she accepts much smaller returns, pays much more in fees and never earns a return that is as great as inflation, so he or she never keeps up with the increases in the cost of living, because his or her investments do not grow in value over time.
Good investment decisions result in growth of money, but they are subject to the ups and downs of market volatility, with no guarantees. Good investment strategies recognize this and use category allocation, diversification among types of categories, low fees, reinvestment of all earnings, a long term view of investing, selection of good quality funds and a discipline of sticking with the plan as a way to reduce market risks. The fact is that this generally works.
A famous investor, Sir John Templeton, who gave many speeches on this subject for over 50 years, often said that he only needed to be “right” in his investment choices about 65% of the time in order to beat inflation and produce a better-than-average investment return. Statistical data has proven that he was right. With so many years gone by, it has been studied over and over again. You do not have to “win” every year with an investment strategy to achieve enough growth of your money to retire comfortably. You do need a sensible strategy, and time to let it work for you, but getting a great return every year for decades is not only not realistic, but is also not necessary. Warren Buffet, one of today’s most respected investors, has said pretty much the same things that were said by Sir Templeton, adding that when he buys an investment, he does not generally intend to ever sell it. He buys investments that he believes will grow in value over time. He is not always “right” but he is “right” enough of the time for his investments to grow in value. The result is one of the largest fortunes in the world. You probably do not want (or need) that much wealth but you can certainly use the strategies of both of these successful men as investors.
As I said, relying on your emotions for investment decisions is a 2-side coin. Fear is one side and the other side is greed. One is as bad as the other. Being greedy will lead an investor down a crooked path towards being sold overly risky investments or deals that cannot, and do not work out. Some of these poor investment decisions are based on high returns that are tied to high risks. Some are private deals set up by someone with a good idea but no business experience. Others are scams that promise quick returns that far exceed the norms in the market.
I recall an interesting experience one time when I was teaching an investment class at a university during a spectacularly good year for stocks. The class was being held during a winter quarter schedule and we were in the classroom late in January at about the time that the mutual fund markets were reporting the annual returns of the prior year. Money magazine had published a front page story about returns of over 20% for that year just ending and my students were all over this story, excitedly talking about it. I asked them what they would expect as an average annual return on a good quality mutual fund and was shocked to hear most of them say that they figured they could earn about 25% per year by investing in a good mutual fund!
The problem here was that they had caught the greed bug. It was an unrealistic expectation but they wanted it and disregarded the historical data that they had been learning about all during the class. I was dismayed to have to bring them back to reality. Normal, historical investment returns for stock mutual funds at this time was about 10% per year on average, not 25%. As we talked about this fact, they gradually began to see the effects of greed on themselves, and it became a great learning point in the classroom for the rest of the class schedule. The very thought of getting an average return of 25% was too much for many of them initially and pushed them over the top into greed mode, but most of them came back down to reality and learned a valuable lesson as a result. If you do the math, getting an average return of 10% per year, year after year, is excellent; it will double your money in about 7 years. That is not greed. Getting the historical average return is a realistic goal if you have the discipline and strategy in place to try to achieve it.
So, avoiding the most classic investment mistakes generally mean to avoid the fear/greed risks of relying on your emotions to guide you in making investment decisions. It is not complicated, but it is hard to do. We are emotional beings and are often not very rational about money. Be forewarned, therefore, to avoid emotional decisions if you do not want to outlive your money. The solution to Risk #5 is a little more complicated, because investing can be tricky if you do not really know what you are doing. You may need expert help with this, but whether you do or do not, a financial plan is the best way to solve this problem. A financial plan will include an investment strategy and keep track of your progress towards your accumulation goal. It is a bit more work but it is worth the effort.
There is another risk out there that causes many retirees to lose money. It is adult children who beg and borrow from their aging parents. This is Risk #6.
Every now and then when I talk to someone with adult kids, they mention loans and gifts that they have made to their adult children. I listen with interest, because I know that oftentimes, they cannot afford to be lending or giving away money.
Now, with their health in a sharp decline, they will soon need home health care. This will add to their monthly expenses but they have less than they need to be able to pay for this added expense because they have given away too much of the principal of their investments over the last few years. Despite repeated warnings that they could not afford to give their son large lump sums to bail him out again and again, they could not tell him no. Today, they face running out of money. Risk #6 is hard to solve, but if you find yourself in the habit of giving your adult kids money, it is time to sit down and put pencil to paper or set up a computer spreadsheet to determine if you can really afford to do this. I have given this advice to people who say “it’s only this one time” but it turns out that once you do it, in most cases there will be repeat requests that you will find difficult to say no to. The solution is not to start this bad habit in the first place, but if you have already done so, stop it now. The exception, of course, is if your adult child is truly unable to support him/herself due to an impairment that will not be resolved. Otherwise, solve the problem by learning to say “no”.
Finally, a very common problem is Risk #7: not being able to set up a stream of income from your retirement money that will outlast you. This situation is also a little bit more complicated than some of the others. When you retire, it is necessary to figure out not only how much you have available for retirement in total, but also how much that total can be expected to produce in monthly income, for life.
If you have a pension and are married, it is unwise to choose to take your pension as a “single life payout”, because it will cease entirely at your death, which will mean that your spouse, if living at the time, will get nothing. In most cases, you cannot choose this option without your spouse waiving his or her rights to a survivor pension from your plan, but spouses do sign the waiver sometimes without realizing what they are doing. Make sure everyone does understand this option if it is available to you at retirement. Generally speaking, it is not a good idea for married people. A pension will pay you a set amount, probably not with any increases over time (although a few do include COLAs – cost of living adjustments). It will last a specific period of time, either your lifetime/joint lifetimes with a spouse, or a set number of years. Once you make your choice for the time period, the dollar amount can be figured out. It is commonly a formula of about 2% per year X the number of years/months that you were a participant in the pension plan X your average recent salary (often the highest of the last 3-5 years). As an example of this formula, if your average salary for the last 3 years was $65,000 and you worked for 25 years as a pension plan participant and your plan pays a 2% benefit using this formula, you would receive a pension of $32,500 per year. The math is 2% X 25 = 50% of $65,000 = $ 32,500 = $2,708 per month.
Let’s say that you also will get $2,200 per month in Social Security and assume that you will be old enough for both the pension and the Social Security to get the full amounts of each. Your pension of $2,708 + your Social Security of $2,200 will total $4,908 per month in retirement income. If that will be enough, great. If not, you will need more from investments. The time to solve this problem is years in advance of retirement, but if you are ready to retire soon and have not figured this out, we strongly recommend you begin the process ASAP.
So, if you do have a pension, part of the problem of how much income you have has been solved, regardless of whether or not it will be enough. You know the amount, and that is the first step in the calculation. The second step is to figure out how much your other retirement plans or investments will produce.
If your other investments include rental income, add the net/net of that income to your total. The net/net is the free cash flow after real estate taxes, property insurance, maintenance and repairs and mortgage expenses on the property. In some cases, there is no net/net. But once the property is paid for, there should be. Add this to the monthly income that is expected.
If your other retirement or investments are stocks/bonds/mutual funds/exchange traded funds etc., they should earn interest (from bonds and cash), dividends (from stocks/stock funds) and perhaps royalties (from other types of investments). These sources of income are routine and will be produced monthly, quarterly, semi-annually or annually, depending on the specific investments you own. You will also often have capital gains income from investments (if/when they are sold). All of these sources of income are added to your account value and priced daily in the market. As those values grow, the income that they can offer you grows also. In our example above, let’s say that your total account value from other retirement plans or investment accounts at the time that you retire is $500,000 and you or your advisor calculate that you can take the income + some of the growth from the total, at a rate of $20,000 per year, or $1,667 per month without spending any of the principal.
If you do not have a pension, you will obviously need to have more investments than if you did have a pension. You can do this with a SEP (if you are self-employed) which allows a maximum contribution annually of 25% of your gross self-employment income, or $56,000 (as of June 2019), whichever is greater, or various types of IRAs, which allow contributions of lesser amounts. About half of workers without a pension do have a 401-K plan, a 403(b) plan or some kind of deferred compensation or defined contribution plan that they can contribute to in lieu of a pension plan, so these retirement plans are important in the calculation of how much income you will have at retirement. Whichever you have, the calculation process is the same.
In early retirement years, this is very important, because you will likely live longer than your ancestors and you may need to increase that monthly income as time goes by. The bottom line is that you should try to grow your principal rather than deplete it, in order to have inflation protection.
Obviously, if you do not have a pension (few people do), you will need to accumulate more if you want more income. Unfortunately, many people either do not know how to figure this out or just do not bother, and they end up with too little accumulated and then take out too much, depleting the principal.
Taking out more than you should, especially early in your retirement years, is a major mistake. Keep in mind the effects of inflation. You will, without question, need more money in 10 years than now, so if you can actually grow some or all of your retirement assets during those 10 years, the income you will get from them can be increased. However, if you deplete the principal, your income cannot be increased and in fact, will need to be reduced. For most people, that is not the goal. You do not want less income as you age; you will probably want more. The solution to Risk #7 is to get a realistic and correct calculation of how much income you can expect and a projection of how long it will last.
So, in summary, if you want to outlive your income, you can’t wing it. You will need to do some work to achieve the goal of having enough to sustain yourself as you age. Doing the work means knowing the risks; knowing the risks enables you to take steps to reduce or avoid them. It never works to ignore risks, and even if they are difficult to manage, there are always ways to work around them, reduce them, minimize them and in many cases eliminate them. Do it yourself or get some help, but whichever route you take, get started now to avoid running out of money after you retire.
On the Web:
Representations of fact and opinions in comments posted are solely those of the individual posters and do not represent the opinions of Sitnews.
E-mail your news, photos
& letters to firstname.lastname@example.org