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Council Post: ‘Get Real’: Setting Up Reasonable Expectations For Your Retirement Savings



Tracy Lownsberry is the owner and chief analyst at Up North Retirement.

When we ask investors about their realistic expectations for returns on their retirement portfolios, the answers are often anything but: “Anything from 10% at the bottom to 15% at the top” is a common response. Keeping in mind that the average stock market return is around 10% per year, as measured by the S&P 500 index, it’s easy to see why these scenarios, particularly at the higher end, are somewhat overly optimistic.

Part of that is what I call the difference between perception and perspective. The perception we commonly see with clients is that they’ll automatically be able to get 8% from the time they retire to their death. Perspective is understanding where that 8% is coming from; there’s a difference between a portfolio with very little risk and one with lots of risk and downturns. There’s a concept called the sequence of return risk: I can show you a portfolio in which we consistently took out 6% and never ran out of money; I can also show you a portfolio in which we took out 4% and did run out of money in under 15 years. The difference is whether we’re talking about withdrawing money over a five-year, 10-year, or 30-year period—long-term and short-term averages can be very different.

Another area where we see investors’ perceptions misaligned with perspective: taxes. For whatever reason, there’s this perception that somehow the rich manage to reduce or eliminate taxes through some secret strategy that isn’t available to everyone else. Unless you’re maintaining an off-shore account in the Caymans, or comfortable with courting jail time for tax evasion, you need to follow the tax code. What you can do is optimize your savings through ROTHs (if eligible) or other types of tax-deferred plans such as employer-matched ROTH accounts, health savings accounts, indexed universal life insurance or even certain trust setups. But, there is no magic tax-elimination lever.

The cold hard truth is that 98% of large-cap growth funds and 90% overall of actively managed investment funds underperform, in that they fail to keep up with or surpass the S&P 500 returns. These abysmal statistics, combined with investors’ misunderstandings around maintaining and growing their savings, result in many people being unprepared for retirement.


A Clear-Eyed Approach

On average, we see most investor’s returns falling between the 6 to 7% percent marks—sometimes up to 8%, but that’s unusual. (Obviously, some outliers happen to have bought Apple stock at the right time, or something like that, but this is unusual.) When someone wants to shoot for a 6% return, but with a significant amount of safety behind it, in my experience they’ll often beat out their friends shooting for an 8% return with a lot of risk (depending, of course, on what stage of their life they are in, and how long they can go without touching their investments). There’s a lot of talk about whether or not the 60/40 portfolio is still the best investment strategy; we think combining the 60/40 strategy with the “Rule of 100” (taking your age and subtracting it from 100) yields a more optimal plan in general. The number you have left over is the percent of your assets that should be in “risk”—the rest should be in safer vehicles, such as annuities. (Full disclosure: I’m a big proponent of annuities.)

Another thing: A lot of investors are familiar with the “4% rule,” which states that—for your portfolio to remain healthy—you cannot withdraw more than 4% at any given time, adding inflation onto that number yearly. (Note that this is based on a 60% equities to 40% bond portfolio.) However, research has shown this is no longer feasible; at this point, it’s safer to abide by a 3.3% rule. This has been a painful reality for some investors to accept. But, drawing down the principle in your portfolio means you’re positioning yourself to outlive your money, which can leave you in a perilous situation, assuming that’s not your goal.

Retirement 101

So, what if you’re mid-career and you’ve so far done none of the “right” things to safeguard your retirement? There are some steps you can take to correct course.

Step one: Take a look at your debt. I’m a big fan of something called positive debt arbitrage: If you can invest the amount that you would use to pay off your debt and get a higher return on it, then it makes sense to do that. However, many investors simply don’t have the ability to do that—and in that case, they need to work on paying off debts, and quickly, since those can be incredibly handicapping. Start paying off little debts such as credit cards, vehicle loans or anything super high interest (say, above 5 to 6%). Clear those debts as quickly as possible.

Step two: Establish an emergency fund. I recommend six months’ income in that fund, which should then be put into a high-yield savings account. Some of these are yielding 5% returns right now, which is fantastic; if your money is in one of these accounts, you know it’s doing something, as opposed to just sitting around getting hammered by inflation.

Step three: Depending on your tax bracket, make sure you are matching your 401(k) inside of any employment plan that you have. Simply put, that is free money. Even if it doesn’t perform that well, you should still be collecting it. In addition, it’s a good tax incentive for you to lower your tax bill. Make sure to research if ROTH accounts are available. These may be a great option to allocate some of your money inside of your employer-matched plans.

Step four: Fund a ROTH account if you are in the income limit for it, from a tax perspective. It doesn’t take much to fund a ROTH account—they max out around $6,000 per year. But your ROTH contributions are tax-free; later they grow and compound tax-free, and when you die, they pass on tax-free. You can plan for retirement a lot easier with tax-free money (see above—this is one of those ways to optimize your portfolio while staying within the tax code). If you are a business owner, do some research on Solo 401(k)-to-ROTH conversion options.


Step five: Once you’ve done all these things, you can start focusing on putting together a strong brokerage account. These must be funded consistently, so buy into the market at dollar-cost averaging. You’ll win some and you’ll lose some, but if you have time to do this consistently (that is, you’re not trying to retire tomorrow), this strategy will benefit you over time.

A Final Thought

Realistic retirement planning isn’t particularly glamorous. It’s often an exercise in patience, in playing a long game and living thriftily within your means. There are no secret levers or magic funds, and surprise windfalls are rare. But, if you can take a considered and clear-eyed approach to the process, relying on strategies that work as opposed to pie-in-the-sky schemes, you can set yourself up for a successful and comfortable retirement in the future.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?

Source: Forbes


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