subject: Retirement Income Adequacy [print this page] When we first start our careers and begin to put money into 401(k)s, we do so with the objective of retiring well. At that point we have not saved much for retirement and do not have much to lose so we follow the prevailing advice and keep putting money in through all market cycles. This can actually work in favor of the younger crowd (those that will not be spending their retirement money within the next decade) with the power of Dollar Cost Averaging.
As people get closer to retirement, and therefore, closer to the need to spend the retirement assets that they have accumulated, their objective of saving to live comfortably in retirement does not change, but the primary risks of what can derail them from that goal change considerably. Our top three concerns for people closing in on retirement and those that are already retired:
Losing investment principal to the markets.
If somebody that is in their 20s and has done well by accumulating $25,000 dollars in their 401(k) account loses 25% of their portfolio to decreases in the markets, they have two things working for them:
They do not have to spend the money.
25% of $25,000 is not a lot of money on a relative basis. The market losses experienced in ones portfolio are the exact reason it becomes an advantage: the ability to buy into the markets at a lower level. This creates a lower per-share average cost so when the markets come back, the investor makes back the losses with a factor many multiples higher than the losses that were originally incurred. With that said, if any of the money in the portfolio is spent or taken out of the markets, the advantage is lost.
They have time to recover.
As I said above, the inability to wait for the markets to come back the need to spend the money causes the process laid out to collapse.
Not knowing whether your money will last longer than you.
The question here relates back to our first concern, and what we call the #1 risk of people near or in retirement: The Loss of Investment Principal. To ensure money will last, one must find investments whose principal is assured. Then set up those investments so they pay income. The thinking here is that the income coming off of these principal-assured investments can be relied upon with a high degree of certainty. But one must also continue to guard against inflation. Principal-assured investments do not typically provide the highest returns. Therefore, a near retiree/retirees portfolio must be balanced between risk-based investments that have the ability to combat inflation and the principal assured investments that produce strong income.
Creating an effective structure for the efficient distribution of assets.
The main focus here is the minimization of taxes, but investment costs and fees can eat away at a nest egg too. By the time they reach retirement, many have different types of accounts IRAs, Roth IRAs, 401(k)s, Brokerage Accounts. Money taken out of these accounts will be taxed differently. There are many things to consider when structuring a portfolio for distribution: What types of investments should be held in each account? In what sequence should the money be spent? Will any of the above affect my Social Security and the level to which I will be taxed on it?
by: John L. Scott
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