Psst! Did you know that Uncle Sam has saved up $1 million for your retirement?
Sounds crazy, but that’s the net effect of a typical couple’s earnings. A fully retired worker in 2013 can expect $2,533 a month, the government estimates. Over a year, that’s $30,396.
Throw in benefits from a part-time income earned by a spouse and you’re up to $40,000 a year, which is what you would expect a $1 million “safe” portfolio to generate over the remainder of your life.
Put another way, $1 million times 4% equals $40,000. It’s simple math, but this basic calculation gets by some folks.
Now, I know you’re expecting the government to go bust, dramatically change Social Security or some other retirement risk. I’m not here to convince you otherwise.
Rather, I want to point out why it’s important to consider your retirement investments in the context of all the money you expect to have coming in once you reach that magic number, your retirement age.
As we know from recent experience, your ability to withstand a precipitous drop in the markets lessens as retirement nears. That’s one of the retirement lessons from 2008 that many people learned too late.
It’s thus very important to regularly review the level of risk in your investment portfolio — to make sure you’re taking enough retirement risk.
More retirement risk, not less
You heard me right: You might need to take more, not less, retirement risk as you get down to that last few years of work and saving.
A lot of advisors explain investment diversification as a 60/40 split of stocks and bonds that you reverse as you near retirement. But that simplistic approach can fail to consider cash you have in bank accounts, annuities you already own, pension income, part-time work and Social Security.
It is possible to have too little risk and, as a result, to outlive the purchasing power of your savings. For instance, a couple with Social Security that brings in $40,000 a year has, as I mention above, what amounts to a virtual $1 million bond portfolio working on their behalf.
If you also have a separate $1 million IRA portfolio that is 60% bonds at retirement, the bond portion of your total asset allocation is now 80%! If you own annuities, have a pension or both, the picture worsens dramatically. You might be 95% in bonds and not realize it.
That’s why I say “too little risk.” You might be better off putting more of your IRA money into equities to offset long-term inflation, or at least aim to return to a real 60% bond allocation.
Back to the inflation problem. It’s been low for years now and, as far as anyone knows, will stay low a while longer. But inflation eventually will begin to rise.
Once that happens, bonds are going to be a risk to your portfolio, greater than they’ve ever been after a multi-decade bond bull market.
Interest rates rise in response to economic recovery, which means inflation will rise as well. In that case, you will need more equity exposure to overcome the long-term effect of falling purchasing power. Even tame inflation means your money in the future will buy half of what it does today, should you enjoy a retirement lasting decades. Barring major health problems, it’s likely that you will.
If your portfolio is built around the 60/40 model but your bond market exposure is more like 80% or higher, you simply won’t have enough equities “oomph” in your retirement plan to go the distance.
Am I saying buy stocks today? Of course not. But it is important to consider the true level of each asset class in your retirement plan and to make adjustments accordingly, before time inevitably passes and it’s too late to make a difference.