When working people enter their late 50s or early 60s, most begin to take stock — many for the first time — of their retirement plan investments. Often, they are shocked to find that the reality underlying their plan to fund retirement is dire, even catastrophic.
Now, this is not an article to scold savers who started late. Or folks who faced difficult financial events along the way. There’s no point in feeling bad about where you are. It changes nothing.
Nevertheless, a realistic “fix” for retirement investing is hard for most to fathom. Pulled by costs such as kids’ college bills, health care and a mortgage, they find there’s just enough money to get to the end of the month and no more.
Cutting costs is an obvious start. Lowering expectations another. But by far the worst course of action to fund retirement is the one in which retail investors seem to place the most faith: That they will simply get lucky.
Wall Street loves this mindset. If you watch enough financial cable TV you could easily become convinced that your own smarts are enough to “win” at the game. The hosts, the guests, the advertisers, all of them march to the same drum. Beating Wall Street is a piece of cake. Anyone could do it.
If only that were remotely true. John Bogle, the founder of The Vanguard Group, wrote not long ago about “fiduciary duty.” It’s a brilliant argument from a brilliant manager. In summary, his case against Wall Street is that no one can serve two masters.
Wall Street can serve you, the client, or itself. The conflict of interest inherent in money management is nearly unavoidable, one compounded dramatically by the way most money managers obscure from view the real impact of high investment management fees.
It’s a toxic mix. The investor wants an easy answer, a simple escape plan. “Buy this part of the market right now and just wait! It can’t miss!” The seller, our modern investment industry, has spent decades penning a Horatio Alger story of success against all odds, a tale of pluck and skill and grit. How could these two possibly not fall in love?
Yet our soon-to-retire investor should run, and fast, away from these suitors. If you ever wanted to trap a financial adviser or broker and leave them completely speechless, just say, “Show me your fees in writing.” Click! That’s how fast the phone will hang up.
The trouble, of course, is that dumping the high-cost, high-risk approach doesn’t address the immediate problem: How to retire on time.
It’s important to understand a basic concept of investing. There’s a lot of math in the background, but I’ll try to simplify it. The core idea is to seek an appropriate “risk-adjusted return.”
Fund retirement with less risk
At its most elemental, risk-adjusted return means comparing apples to apples. If you know the return on an investment with a specific level of risk, now calculate the risk of a second investment in such a way as to make them comparable.
Put another way, if you know a Treasury bill is paying you 4% with the full backing of the U.S. government, would you buy a stock that might return 5% at nine times the risk? How about three times the risk?
Yet another way, if you are targeting an entire portfolio return of 7% (doubling your money in about 10 years), how much market risk are you taking on if you stretch for 8%? Or maybe 9%?
The simple answer to fund retirement, one John Bogle would ask of a good fiduciary manager, is “exactly as much risk as you can stand and no more.”
If your time is short (say, less than 10 years) and your patience thin, your ability to withstand a doubling or tripling of risk is limited, understandably. Nobody wants to see their retirement plan crumble to dust weeks before leaving work.
Sadly, the fundamental message of Wall Street to the legions of near-retirees seems to be that greed is good, that risk is the key to success. In reality, what investors need is a plan that takes their investment risk tolerance into account and which can adjust accordingly in the time they have left to invest.