“Our biggest concern is our ability to sustain current living expenses and absorb the medical insurance premiums,” Justin says. “Now that I’m faced with the reality I’m still at the ‘deer in the headlights’ phase. I want to pursue my interests in photography and making sawdust. When Kitty retires, we will want to be able to take vacation trips.”
The Monmouth County couple, whose names have been changed, have set aside $160,731 in 401(k) plans, $9,513 in IRAs, $10,034 in an annuity, $3,856 in a brokerage account, $12,151 in mutual funds, $79,339 in savings and $28,752 in checking. Justin will receive a monthly pension of $2,670 when he retires, and Kitty will receive a $600 monthly pension when she leaves work in two years.
The Star-Ledger asked Doug Buchan, a certified financial planner with Tilson Financial Group in Watchung, to help Justin and Kitty realize their retirement dreams.
“They describe themselves as ‘confused conservatives.’ Hopefully after my advice, they’ll be less confused and less conservative,” Buchan says.
He says they can make their retirement time line work, but it’s not a slam dunk. They’ll have to be smart with their spending and their asset allocation, Buchan says.
That’s because Justin and Kitty have a long retirement to think about. If they live to the average life expectancy, given their respective ages, one of them is going to still need an income in 27 years, Buchan says, so they need to think in terms of a 27-year retirement.
“So many folks entering retirement miss this key critical piece of data,” he says.
And, in 27 years, one thing is for sure: Prices will be significantly higher, Buchan says.
The couple estimate they spend $6,000 per month, excluding savings. Assuming a modest 3 percent inflation rate, $6,000 of expenses in the first year of retirement will cost about $13,500 in year 27.
When considering a 27-year retirement, Buchan says the elephant in the room is purchasing power risk — the risk of your expenses going from $6,000 to $13,500 — rather than market risk, or your portfolio going down in the short term. Buchan says it’s critical to take on at least some market risk to help protect against the inevitable inflation bite.
The good news for this couple is they currently live within their means, they have limited liabilities and they have modest pensions to help them out along the way. Based on their retirement income and projected expenses, Buchan says they will tap less than 3 percent of their portfolio annually for the next 12 to 15 years, which he says is excellent.
“This provides further ammunition to invest in equities and be less conservative,” he says.
Buchan ran some Monte Carlo simulations (computer-generated “what-if” scenarios) which further drive this point home. Justin and Kitty are twice as likely to not run out of money if they earn an average of 7 percent, with a 78 percent chance of success, compared to a less than 40 percent chance of success if their investments only earn an average of five percent.
“The only way to earn a greater return is to take on a bit more market risk or market volatility,” Buchan says. “If an adviser or broker tells you he can earn you more return with less market risk, run for the hills.”
He recommends they invest at least 50 percent of their assets in globally diversified equities for the long term. If they can avoid the all-too-common propensity to panic when inevitable bear markets come, they should invest even more in equities, he says.
“Remember, in 27-year retirements, purchasing power is the big risk, not market risk,” Buchan says. “There has never been a 27-year period where the global stock market has gone down. And, there has never been a 27-year period where prices didn’t go up.”
If 100 years of history is any guidance, Buchan says, globally diversified stocks is a much better protection against inflation than bonds and cash.
Finally, Buchan says, this couple shouldn’t be shy about hiring a financial planner for some guidance along the way. A good adviser will certainly cut down on the confusion and greatly increase their peace of mind as they enter their retirement years.