Money Obedience

When you use a retirement planning calculator you need to think about how many years you plan to spend in retirement. This thought makes me chuckle. How are we supposed to know how many years we’ll live after we actually stop working?

Think about all the uncertainties surrounding our retirement planning in the first place. How much can we save each month? What if unforeseen expenses hit us? How do we invest our savings? How will our savings grow? What do we do if we face a decline in our investments as most of us have recently? – The answers to these questions depend on so many different things some of which we can control, but some of which we cannot control.

And now we even have to think about how many years we plan to spend in retirement? Now, the answer to this question largely depends on our life expectancy. If we retire too soon and live too long, we may run out of money. If we retire late and die shortly after retirement, we kind of got cheated out of our golden years. Obviously the safest thing is to retire later because you don’t want to run out of money at 88 if you are blessed with a long life after age 65 (when most people think of retiring). If that happens to you, just think how hard it could be to get a new income source at that age. What should be done then?

Well, I don’t really have an exact answer. As is the case in most things “finance” there are many different ways to handle risk and uncertainty. So, I will tell you what I did. I used a few of the life expectancy calculators listed on the page “Life Expectancy”. Funny enough they all came within a couple of years of each other – and can you believe that they all tell me that I will hit 90?

Just to be on the safe side, I added a few more years when I plugged my life expectancy into the retirement planning calculator. (I took an average of all the ages given to me by the life expectancy calculators I used, and then I added 7 years.) I have two reasons why I want to add a few years “just in case”. First, as I said above I don’t really want to run out of money when I will be too old to find work. Second, my yearly health check-up revealed yet again another good surprise. My pulse, my blood pressure, and my cholesterol are even lower now than they have been in the past several years. (Did you know that an annual health check-up itself increases your life expectancy?) I would imagine that my body may hold out even longer than what the life expectancy calculators suggest.

Be aware that there are, of course, no guarantees. Life expectancy calculators only work with averages – they don’t tailor to individuals. But we are all individuals and none of us is really the “average.” Only as a group can we make up an average. Life expectancy calculators can only be used as a very rough guidance about how any given individual might live. Even though I do not treat the result as hard facts, I still enjoyed filling out the questionnaire on these life expectancy calculators – especially since they gave me such a good forecast!

A lot of people lost a lot of money in the recent decline of the stock markets. My wife and I were fortunate - we did not lose a lot of money. To be sure, we lost money, but it was not too bad in the scheme of things. And, to boot, we made some money back over the last few months, just like most savers who invest with their savings.

We invested our retirement savings in a pretty conservative way. We did this for two reasons. For one, a retirement calculator indicated that a conservative way of investing was a good (enough) strategy for us since we saved a good amount of money for retirement each year. We felt that we didn’t need to take the risks that go with the quest for high returns. Another reason is this: in my past line of work, my monthly income somewhat depended on the stock markets’ performance – so I was taking on a lot of risk as it is, just by working in a market-related job. If I had invested heavily in the stock market with my earnings I would double my risk exposure, and that did not seem sensible to me.

We’re in a somewhat different scenario, now that my income is not as dependent on the well-being of financial markets anymore. Some might say that I should probably invest a little more aggressively. Why am I not doing this?

First of all, I recently re-checked our retirement planning with a retirement calculator and found out that things are really not that bad for us, savings-wise. A minor adjustment – delaying my retirement by two years – would keep us on track even with a conservative way of investing. I don’t mind this adjustment since I like working and I am not even sure whether I ever want to retire fully.

Second, my source of income may change in the short term. It may become dependent on the stock market again if I find a job similar to what I had, or at least in a related line of work. If that is indeed the case, I would have to switch back to my previous asset allocation anyway. But it’s a good idea to keep one’s asset allocation rather stable, so I don’t see much need to make changes now.

Nevertheless, I will revisit this issue in a few months again - as everyone should. Then, (I hope) I will have a clearer picture about my professional future and income. With new information, I should be able to make a better determination about my asset allocation.

The House Introduces 401(k) Fee Disclosure Bill - finally. Now let’s hope that the folks in Congress will actually pass the bill. The only reason why a bill like this had not been passed sooner is quite simple. Companies who are involved in the 401(k) business want to make money, and lots of it. And they want to make this money very quietly. My guess is that, until now, these companies had enough influence on Congress and/or the President to prevent any such bill from being introduced and/or from being signed into law.

Why is this bill so important? Well, they charge us all kinds of fees just to hold our money – even as they’re imploring us to save for our own retirements. Now that we have lost lots and lots of money with the declining stock market, people finally realize that we have been paying through our noses for the privilege to save for our own retirement. So, we should know how much saving is actually costing us, but many of us don’t. Let me show you an example how these fees alone make it especially difficult to put money away for retirement.

Let’s say you save $500 every month for 30 years and your average return in that time period is 7.5%. In 30 years you will have a nest egg of about $641,000. Pretty nice, isn’t it? But now let’s assume that you are saving these $500 in your 401k account. Let’s say that the various companies involved in the management of your money charge you a 2% fee. That does not sound like that much, does it? But, guess what! Over 30 years it adds up to a nice chunk of money. After you pay the 2% fees ever year for 30 years, your $500 monthly contributions add up to only $445,000 – you’ve “lost” nearly $200,000! Said another way, it comes to nearly 1/3 less the amount that you would otherwise have had! That money doesn’t just disappear - these $200,000 of lost return on your savings go right into the pockets of the companies who are “helping” you with your 401k savings.

This new bill would not eliminate these fees, but it helps to ensure that you know exactly how much of your 401k is taken out by each company involved in your savings. You can use that information to figure out how much these fees will cost you over the years you save. When you know the fees, you can also make an educated decision about how you could best invest your money. Right now it is very difficult for anyone of us to make such an educated decision because we don’t have full information about how much these companies are grabbing. Now do you still wonder why such a bill has not been introduced earlier?

If you’re thinking that this is the kind of information you’d find useful, I suggest you write to your Congressman/Congresswoman and to your Senator to make sure that this bill gets passed.

A friend of mine told me a couple weeks ago that he had sold all stock holdings in his retirement account. He had had enough of the stock market that hit one low after another. Within days of his sale the market staged a tremendous rally. His timing was very unfortunate. Now he is considering getting back into it. So, he asked me for advice. That is how I actually found out what he did. Apparently now he needs a second or third or fourth opinion since he may have lost confidence in his ability to read the market’s movements correctly.

Guess what? I don’t have that ability, either. Nobody does for that matter. Even the best investors in the world don’t get it right all the time. The “only” thing they get right is their understanding of what they are doing at the time they make particular investment decisions. That is the only thing we can be sure about.

When we set up a retirement savings account and we decide how much of our savings should go into stocks, bonds, or cash, we should think about it carefully right at the beginning. We should educate ourselves about the risks involved with each investment and what consequences these risks may have on our savings. And then we should just run with it.

Our appetite for risk does not change that much from one year to the next. However, other things change, sometimes very quickly, like our emotions. Greed and fear are two of these irrational responses to stock market moves. Recently people have been getting really scared about the value of their investments. Fear overpowers their decision making that can lead to a bad decision my friend made not too long ago, which he regrets right now. (He may not regret it a few months from now, unless he bought back into the market at a high price.)

We can only make sure that fear and greed do not dominate our decision making. (Yes, greed used to be a prevalent emotional problem until a few years ago, when the market hit one new high after another. We may just have forgotten greed now since we are all consumed by fear.) We must have a good understanding what we do with our retirement savings from the outset. We must know why we are in the game. Only then will be act like the “big boys” and enjoy success.