This started off as an email to a reader, but I thought that many other readers might find this of some value.
Recently, I received a long email from a very distraught woman (that I’ll call Mary) who has finally come to the realization that she will not be able to retire in seven years as has been her plan all along.
For the past twenty five years, she’s been contributing a regular small amount to her company’s optional retirement plan - about 7% of her salary. Her company has also chipped in about 3% on that savings, bringing her to about 10% of her salary each year in total savings.
She invested that money pretty conservatively - but it’s an investment plan that seems reasonable to me. Half of the money went into bonds - mostly treasury notes. The other one went into the S&P 500 as an index fund.
On average, over the past twenty five years, her plan has returned 7.5% - and that’s a number she’s become quite comfortable with. As her retirement age approached, she began to use that number to calculate forward from her current state - and this enabled her to plan for retirement in 2015.
Then 2008 came along, and at the end of the year, she received her statement. Her stocks had dropped 39% on the year, wiping out about 16% of her overall retirement savings. This one single year had dropped her annual returns from a 7.5% average to almost a 7% average.
The end result of that swing? Unless the stock market has a gigantic rebound over the next few years, Mary won’t be retiring on time.
For most of you, Mary’s story is pretty ho-hum. Almost every baby boomer is going through some version of what Mary is dealing with right now - I can certainly say that the boomers I know are working through what to do.
What intrigued me was that Mary didn’t want help for herself. She wanted to know what exactly she should have done in the past to not put herself in this situation. In her words:
My daughter just started a great job. We’ve talked a lot about this and she doesn’t have any idea what to do with her own money now. She’s worried about being stuck in my situation later on. What should she do differently than what I did?
Here are seven tactics I recommend for Mary’s daughter (aside from get started now).
Contribute a little more. If you’ve decided to contribute 7% to your retirement account, make it 8%. If you’re at 8%, consider bumping it up to 10%. You’ll likely not notice the difference in terms of your day to day spending, but bumping your retirement savings up from 8% to 10% gives you 25% more money to work with in your retirement account - money that might help you retire early, but might also simply help you survive another down year.
Don’t repeat the same formula when you’re 60. If you’re just starting out, going aggressive with your retirement savings is fine - you have plenty of years to recover from any early down years. However, don’t just keep riding with that same strategy because it’s comfortable and it’s worked in the past. Over time, you should gradually move your money into something more conservative - that usually means out of stocks and into something more stable, like bonds.
An easy way to do that is with a target retirement fund. Most retirement plans offer an option called a “target retirement fund.” The way it works is pretty simple - they do the gradual shift to more conservative investments for you over time, so you’re not caught holding the bag when it comes to another 2008.
Assume some bad years - and don’t be despondent when they happen. Over the course of a career, there will be some bad economic years. Know this up front - you can’t expect every single year to reward you with a big return. When the bad years happen, remember the good years - and if you’re getting close to retirement and realize you can’t afford a really bad year, make your retirement allocations more conservative.
Don’t be afraid to ask for help. Many people feel as though retirement planning is a burden they must carry themselves - and they often put it off or make bad choices simply because they’re unsure what they’re doing. Don’t fall into this trap - ask for help. Ask the person in your workplace who manages such plans. If you’re really unsure, ask a fee-only investment advisor for help. Don’t put it off simply because of ignorance - get educated and get going.
Don’t invest in something you don’t understand or seems risky to you. This is a great rule to follow. If you’re looking at your investment options and you don’t understand some of the options, learn more about them on your own. If you’re still confused - or if it seems overly risky - don’t invest. Everyone has a different level of risk tolerance, and you’ll only regret it if you exceed your risk tolerance, particularly in your retirement account.
Don’t plan for a “full” retirement. Assume that your retirement will contain some degree of activity that can earn an income. Many people after retiring seek out some sort of activity to fill their time and a part-time job or a seasonal job can be just the ticket. Instead of trying to figure out how you can possibly replace your whole income in retirement, focus on just replacing most of your income under the assumption that you’ll want to remain active in retirement.
The Simple Dollar chronicles a man's road to recovery from "total financial meltdown." As author Trent Hamm puts it, "The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two." We'll post a couple of entries a week, but you can check out his writing daily at www.thesimpledollar.com