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How to Hedge Your Retirement Plan

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The following is a guest contribution from blogging friend Stephen Chen, the founder and CEO of NewRetirement, an online retirement planning service focused on helping people prepare for and make the most of their resources in retirement. Steve’s experience spans financial services, education, investing and retirement planning across firms that include Charles Schwab, Wells Fargo, Embark, SEC Ventures and Dimensional Fund Advisors.

I like to sleep well at night. For me that means not worrying and being confident about the future, which I try to achieve by investing and trying to maintain balance across four areas of life:

  1. Health and work/life balance – they say take care of yourself first – so I try (with some limited success) to eat well, exercise and manage stress.
  2. Family, Friends & Community – studies show that relationships & community are key to happiness and health. 
  3. Purpose – nobody wants to walk around aimlessly; even if you no longer need to work for income most people still want to use their time wisely, stay relevant and contribute.
  4. Financial confidence & visibility – building and maintaining enough assets & income to last as long as I need.

I believe Darrow is a great example of someone who is effectively managing across all of these areas.

There are many things that blow up the best laid plans.  Some we can control and some we can’t.  Below is a list of big risks and some ideas about hedging them based on my own experiences and what we’ve observed from our retirement planning users.

From my perspective the biggest risks fit into just three big buckets:

  1. Your own financial behavior
  2. Your own lifestyle choices
  3. Unknown risks

Your Own Financial Behavior

From my perspective the biggest risks are created by an individual’s own financial behavior.  Here are 7 financial behavior risks that threaten your future but are easy to remedy:

You don’t know what you don’t know: Almost everyone — rich or poor and young or old — knows less about personal finance than they should.  A recent study from Fidelity measured financial knowledge.  On a test of basic financial topics, the average that people got right was a mere 30%.   Nobody got all the questions right and the highest grade was a mere 79%. Can you do better than average?

  • Hedge: You don’t have to become a financial advisor, but you should probably commit to continued education about personal finance.  Read books, read blogs like this, use tools and participate in online communities like Bogleheads and DoughRollers.

You don’t have a retirement plan: This is probably a big financial risk to your retirement, but the easiest to fix.  Lots of us have retirement plans… in our heads.  This is not adequate. 

  • Hedge: You don’t need to read complicated books about municipal bond ladders and commodity futures to achieve a more secure retirement.  You just need to understand your own money. The NewRetirement retirement planning calculator makes it easy to get started and manage your own plan over time.  Enter some initial information about your finances, see where you stand and then start making changes and see what is possible — every time you update your data, you’ll get detailed feedback about how your retirement forecast changes.  

Not saving enough: How much to save is the most common retirement question.  And most people don’t save nearly enough.

  • Hedge: A good baseline target is to try to save 10-15% of your income. According to a survey of our users – the best retirement planning decision they made was to start saving early in their career.  The best
    way to figure out how much you need to save is to project how much you will want to spend in retirement and then work backwards. 

Bad investing decisions: This was the #1 mistake cited by our users and it can come in many forms:

  • Not investing at all or enough – 58% of retirement savings is in cash  (Taking too little risk is a risk in itself.  I’m personally guilty of this – I save, but have been underinvesting which is costing me.)
  • Investing in bad assets
  • Not properly diversifying & not rebalancing
  • Hedge:  Invest in the market broadly (equities, fixed income, international), use low cost funds, diversify and rebalance.  Studies show that portfolio allocation drives most of your return.  Automated diversification & rebalancing has been commoditized and is available from most firms for ~ 25 basis points.

Not adjusting your plans:  Lots of people set up their retirement finances and then just let it ride.  However, the reality is that “the only constant is change” and you really should assess your plans on a regular basis and adjust as necessary.

  • Hedge: Set up a quarterly reminder to go over your plans and make adjustments.

No Budget: A Gallup poll found that a whopping 68% of Americans do not maintain a household budget and a much greater percentage have not thought about the details of exactly how much they’ll spend each month and year in retirement. 

Doing nothing or avoiding the problem: Are you avoiding/ignoring paralyzed by fear?  Not sure where to start?

  • Hedge: Embrace the fact that the #1 financial worry for people is “Not having enough money for retirement” –  64% of people are worried about this, so join the club.  Use tools like the NewRetirement Planner to set goals, get educated, build and maintain a plan that you understand.  Create plans for how you would handle good, average and bad scenarios.  You might also want to consider professional help.  Using a financial advisor (who’s a fiduciary) won’t protect you from all potential peril, but they can often help you avoid major disasters.  Learn about the key to a successful relationship with an advisor.

Lifestyle Choices

The lower your cost of living – the easier it is to achieve financial independence.  So it pays to be thoughtful about your lifestyle choices.

Where you retire & housing costs: Where you live is a huge financial factor and a big driver of lifestyle satisfaction. 

  • Hedge:  Carefully consider where you might want to retire – even consider trying out different places by renting first – I know Darrow is testing different locations.  If you are choosing a location – factor in taxes, cost of living, community, proximity to family and healthcare.

Your health: The average out of pocket health care expenditure for a 65 year old today will be a whopping $260,000 — not including long term care costs.  Healthcare is the second biggest retirement expense after housing.

  • Hedge: If you are in good health, you’ll spend less on retirement health care costs.  Engage in regular exercise and follow a healthy diet to keep the pounds off and keep your blood pressure low. Cutting out alcohol and cigarettes can also help you avoid possible medical conditions and expenses in the future.  Here are 12 ways to save on retirement healthcare.

Stressing out about money: Of course you need to worry about finances.  However, if you want to achieve happiness, you should probably consider and value time more than money.

Research published in Social Psychological and Personality Science, found that 64% of the 4,415 people surveyed valued money more than time. However, they also discovered that the respondents who chose time were — on average — happier and more satisfied than the people who chose money. 

  • Hedge: Take a step back and think about what’s important to you and what makes you happy.  You may find that low cost activities like volunteering, hiking outdoors and time with family and friends are key to it.  You may be less worried about retirement if you focus a little less on money and more on how to spend your time.

Retiring too soon: Retiring in your sixties only became a thing in the last few decades. It used to be that people either worked until they died or until they could no longer physically work.  Today many of us are pretty active and able in our 60s, 70s and even 80s.  Just look at some of these amazing accomplishments by people in their 80s and 90s

  • Hedge:   For most people – their retirement date is probably the biggest factor they can control around their risk of running out of money.  The longer you work – the less you need to rely on your savings and the more time your investments have to grow. Use a retirement calculator to see what happens if you delay or move up your retirement date.

Retiring too late: On the flip side, maybe you run the risk of retiring too late.  Data shows that people who have saved their whole lives continue to do that and end up building their net worth until they pass away.  Since no one knows how long they’ll live AND people are essentially self insuring – many planners end up oversaving and not enjoying their wealth as much as they might. 

  • Hedge: There are a few things you can do here:
  1. Ask yourself the “what is enough?” question and weigh time vs. money.
  2. Build up enough assets that you can confidently make them last for longer than you’ll need using a conservative draw down strategy.
  3. Build up enough lifetime income through maximizing Social Security, Pensions and Fixed or Deferred Annuities.  Note – variable annuities are typically a bad idea since they have high fees – but low fee income annuities can be a useful part of a plan.
  4. Some combination – adjust your lifestyle (lower costs) and consider “longevity insurance” – essentially  buying low cost deferred annuities that start at approximately age 85, so you have a fixed planning horizon.

Divorce:  Divorce among retirement age people is skyrocketing. The number of people over the age of 50 who divorce nearly doubled between 1990 and 2010 and this is blowing up a lot of retirement plans since you are now faced with supporting two households.

  • Hedge:  Invest in your marriage and avoid getting divorced. If that’s not possible – then try to manage your divorce as amicably as possible – otherwise be prepared to ship a lot of your wealth to lawyers.

External Factors Beyond Your Control

Longevity: What if you lived to 100, 110 or longer?

  • Hedge: Read all of this article and figure out how to achieve financial independence aka guarantee enough lifetime income.

Inflation: Ignoring the risk of inflation could mean a secure early retirement, but could have dire consequences for the long run.  Over time this can mean a big increase in costs.  From 1913 to 2013, the average US inflation rate was only 3.22% but that meant a doubling in prices every 20 years.

  • Hedge: Factor inflation into your expenses and investment returns – take enough risk so that your real returns (inflation adjusted returns) are high enough to achieve your goals.

Health care costs: Medical care expenditures have risen at a significantly faster rate over the last 10 years than average inflation. That’s a big hit to retirees, who devote a substantially larger share of their budgets to medical care.

  • Hedge: Get educated on the topic and seriously consider health care cost planning before and after age 65 when Medicare kicks in.  We’re hearing from more people who are deferring retirement due to the skyrocketing costs of healthcare.  (Ours went up ~10% and many people are seeing 20-30% increases…)

Volatile financial markets: The financial markets can cause a great amount of anxiety. It is likely that a large portion of your retirement savings are in 401(k)s and IRAs that are likely to hold stock investments that are subject to significant market volatility.  While the market is high today, that could change tomorrow.

  • Hedge: Get comfortable with the risk you are taking in the stock market.  The standard deviation for equities is ~25% – meaning you should expect that in any given year they might go up or down 25%.   Effective diversification, fixed income investments (bonds), alternative assets and annuities are some ways to reduce risk and guarantee your retirement income, and here are some additional tips for turning savings into a reliable paycheck.

Family need: This can come in many forms:

  • Boomerang kids: Today, many adults nearing retirement age are providing financial assistance to their grown children while in the later stages of their own careers – typically prime earning and investing years.
  • Parents: If your kids don’t disrupt your retirement plans, your aging parents might. A 2015 study from BMO Harris found that nearly half of Americans aged 45 to 65 are juggling the demands of caring for children or their aging relatives. Ten percent currently care for both generations while 17 percent expect that they will have to care for the two generations at some point in the future.

You need long-term care: It’s not just your parents you need to worry about.  A 2014 article from Money called long-term care “the retirement crisis nobody talks about.” Plenty of people don’t have enough saved for retirement, but when you factor long-term care expenses in the mix, almost nobody has enough savings.  Unfortunately, not everyone will spend all of their retirement years being active and enjoying all of the fun things they had planned. In fact, someone turning 65 today has a 70 percent chance of needing some type of long-term care services in their remaining years.

  • Hedge: Paying thousands of dollars for a long-term care insurance plan may be a bitter pill to swallow, but it’s something you may have to consider as part of your retirement plan. Again, look at creative ways to plan for these costs. Also, there are new hybrid Long Term Care and Life Insurance or Annuity products that can provide more flexible benefits.

You can’t work: What if you planned to, but are unable to work into your retirement years? Since the economic downturn in 2008, annual surveys from the Employee Benefits Research Institute show that about half of retirees left the workforce before they were ready.

  • Hedge:  Anticipate this scenario and plan for it.  Set aside more and/or prepare to live more frugally.  Invest in your own human capital by maintaining your skills and professional network.  Be open to more flexible “gig” based work.

Change in benefits: The recent tax law changes may pose a risk to Social Security and Medicare if the anticipated economic growth doesn’t happen.  Are you one of the lucky few with a pension? Don’t think you’re immune to disaster. A private retirement plan can change its rules or get terminated. If a plan terminates, participants are usually entitled to all of the benefits they have earned, but if your pension plan ends without enough money to pay all promised benefits, your benefit will be limited to the amount guaranteed by the Pension Benefit Guaranty Corporation.

  • Hedge: Stay politically involved and educated.  Consider what you would do if Social Security or Medicare benefits get reduced.  If you have a pension, be sure to research the solvency of your plan and think seriously about the benefits of taking a lump sum payment instead of monthly income.

Financial scam: Data from the Investor Protection Trust Elder Fraud Survey reported that one in five Americans over 65 has been a victim of financial fraud and a 2011 MetLife Mature Market Institute study estimates that financial exploitation costs seniors at least $2.9 billion annually.

  • Hedge: Be alert and know who you can trust.  Ask a trusted advisor, family member or friend who has financial experience to provide feedback on major financial decisions.  If something sounds too good to be true – it probably is.

If you’ve read this far – congrats you’ve got a lot of stamina and you’re hopefully in a better position to make smart choices about retirement planning!

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