The new challenges of longer retirements

For anyone, retirement is an important milestone, and with today’s lengthening life spans, those retiring at or around age 65 may have two decades or more still ahead of them. With that in mind, it’s vital to structure a retirement plan – including disciplined spending budgets and realistic portfolio withdrawal rates – that can help you enjoy yourself longer, with confidence you won’t outlive your money. This is especially true for women, who typically live longer than their mates.

Longer retirements also mean retirees need to create reliable income streams that do not rely on dipping into their principal, at least not in the initial years of retirement. Developing an income stream usually involves working with components such as Social Security, a pension plan, IRAs, an investment portfolio and other assets. Each person’s mix of investments will be different, but the key is to not deplete them too quickly.

While there are a number of sophisticated computer models that produce formulas predicting how long a well-balanced portfolio will last at various annual withdrawal rates, a little common sense may serve pretty well. It’s obvious that the more you take out each year, the quicker you’ll deplete your retirement portfolio. The key is to find a balance. One quick tip: although many people want to celebrate retirement by splurging a little, the beginning phase of retirement is a time to be extra-cautious about spending so that more of your principal can keep working for you.

Distinguish Between Needs and Wants

Longer retirements also call for a relentless focus on expenses. You will have to be very honest about the difference between needs and wants. Develop a detailed cash flow plan – before you retire – that shows exactly where your money will come from and where it will go. Although many people assume their living expenses will decline when they retire, that may not be true. In fact, it may take a few years in retirement before you really have a good grip on what your actual expenses are.

Two of the biggest challenges for retirees are healthcare costs and inflation. Both are essentially unknowable, and both can have a major impact on your financial situation. It’s wise, therefore, to build a margin of safety into your spending plans, recognizing the reality that prices are going to rise and that you are going to have higher healthcare expenses as you age. For example, you may want to assume that your medical costs will rise 8% annually, while all of your other expenses will increase 4% every year. If they don’t rise that much, you come out ahead. But if you’ve planned for higher expenses, you’re less likely to get caught short down the road.

A critical part of planning for longer retirements is ensuring both spouses can manage the finances. Because discussing death isn’t easy, many couples don’t acknowledge that the spouse who handles the money (usually it’s one person) may be the first to go. That can create real problems, because it means the surviving spouse may have to begin handling financial matters just when he or she is also struggling with the grief and disruption of a major loss. If you haven’t planned for one spouse to take over from the other, you haven’t planned sufficiently.

We’re fortunate to live in an age where many of us live longer and fuller lives. Now we need to plan accordingly. Work with your advisor to develop a plan suited to your unique needs, and stick to it.

Tactics for a low interest rate environment

Interest rates continue to linger at historic lows, and many of the investment vehicles retirees traditionally have relied on for income aren’t producing much of it. Unfortunately, since the Federal Reserve Board has pledged to keep interest rates low until at least mid-2013, the current paltry returns on CDs, money market accounts , savings accounts, Treasury bills and other safe havens aren’t likely to improve anytime soon.

Since your expenses are likely to be rising even if interest rates aren’t, it may be time to consider other investments that can potentially generate higher returns. Before going any further, however, remember that higher returns go hand in hand with higher risk – you can’t have one without the other. So think first about your tolerance for risk, because higher-yielding investments carry with them the possibility – some would say the inevitability – that the value of your principal will fluctuate. One way to make those fluctuations easier to bear is to first set aside a year or two of living expenses in a low-yield but also low-volatility investment like one or more of the traditional vehicles.

Although any decision to commit your funds to a higher-risk investment should only be made in consultation with your financial advisor, here are some areas those seeking higher yields could investigate:

Dividend-Paying Stocks –

Dozens of blue-chip, household-name stocks are currently paying dividends at annualized rates of 4% or more. These types of stocks have generally exhibited less volatility than the market as a whole, partially because of their income component but also because they are usually issued by mature companies with strong balance sheets and a history of managing their businesses well in bad times as well as good. But dividends are not guaranteed – companies can and do lower, cut or omit them – and the prices of the underlying stocks will fluctuate. Diversification is advised, and one way investors can achieve this is by buying a mutual fund that focuses on high-dividend stocks

Real Estate Investment Trusts –

REITs invest in apartments, hotels, office and retail space, healthcare-related properties, mortgages, storage unit companies, and various other types of real estate. Their legal structure enables them to pass the rental income from their holdings through to investors. REITs, which trade on major exchanges like stocks, offer the advantages of liquidity, professional management and diversification. But while some REITs offer attractive yields, their prices can and will fluctuate – and the income they provide is not guaranteed. Additionally, a REIT’s value will decline if the properties it invests in decline. REITs are specialized vehicles; it’s wise to get some expert advice before investing in them.

Master Limited Partnerships –

MLPs are publicly traded vehicles that also are structured to be able to pass their income through to investors. Most MLPs operate in some area of the oil and gas industry, so the amount of income they can generate is often dependent on the price and volume of the product they handle. Again, this type of investment involves risks and is best made only after consulting with your advisor.

Closed-End Funds –

Also traded like stocks on major exchanges, closed end funds raise a set amount of capital through an initial public offering (IPO) and then invest that money in securities such as stocks and bonds. Like open end mutual funds, the daily net asset values (NAV) of closed end funds are determined by the prices of the securities they own. However, the market prices of closed end funds may differ from their NAV as they are subject to buying and selling by investors. Because of this they may trade at a discount or a premium to their NAV. This means the prices of closed end funds will often fluctuate much more than open end mutual funds. In addition, many closed end funds use leverage (borrowing against their portfolios to purchase additional securities) in their quest for high yields, which also makes them riskier.

While higher yields are available and attractive, there’s still no free lunch. Be sure you can handle the accompanying price fluctuations and other risks – and get expert advice before proceeding.

Always diversify

If you choose to accept additional risk for some of your capital in the search for higher returns, be sure to spread those funds among several investment vehicles. Although one may look particularly attractive, concentrating your money would mean that you’re taking on even more risk.

Passing down access to online assets

With more people handling all or at least some of their financial affairs online, it’s important to ensure that your beneficiaries and executor can readily access your “cyber assets” when the time comes. At its simplest, it means storing – and regularly updating – all your online account information, including passwords and answers to security questions, in a safe location and making sure your beneficiaries and executor know where it is and how to access it.

Of course, it’s never quite that simple. Since online scammers are steadily becoming more sophisticated and ingenious, financial institutions are erecting ever-stronger protections to ensure their customers’ accounts aren’t compromised. You want that, of course, but you also want your estate to be settled smoothly, so you will need to think past the obvious preparation of writing your passwords/security questions down and putting them in your safe deposit box or with one of the online storage services.

Bear in mind your executor/beneficiaries likely will access your accounts from their own computers, not from yours, which means those nifty little codes called cookies that reside inside your computer and let the bank know it’s your computer aren’t going to be in your executor/beneficiaries’ computers. In other words, under this scenario, your bank’s computer system will be on guard immediately even though it’s someone you want to have access who is now trying to log in. Also, for their own legal protection, executors may want an authorizing court order before accessing any of your funds, either physically or online.

While passing on our estate is a one-time experience for all of us, financial institutions deal with these situations on a daily basis. Find out what each of your financial institutions is going to want from your executor/beneficiaries and what procedures they follow for granting access to your accounts, then make that part of the information and instructions you store with your passwords and security questions. It may seem obvious, but consolidating your accounts with one or only a few institutions will make this a lot simpler – and the time to do that is now.

Online solutions for your digital data

Online storage sites hold your passwords and other information and release them to your beneficiaries and executors after you’re gone. Prices and policies vary, but the sites generally either require proof of death or establish a procedure (you don’t answer a regularly scheduled email, for example) that triggers the release of pre-scripted messages to recipients you’ve chosen. Deathswitch.com and LegacyLocker.com are examples – be sure to do your
own research. (You still need to update your information periodically).

Planning Tip: Living with market volatility

If the past few years are any indication – and many investment professionals believe they are – higher stock market volatility is likely to be with us indefinitely. High-frequency trading, an uncertain economic environment, and the proliferation of new investment vehicles are among the factors contributing to more frequent swings in the market averages.

While higher volatility isn’t a reason to abandon equities, retirees do need a strategy that will help them remain calm despite the market’s gyrations. A well-diversified portfolio is imperative, because fluctuations in one asset class may be balanced out by changes in another. You also need to have a real handle on your tolerance for risk – ask yourself if you can deal with a 20% decline in your portfolio. If the answer is no, you may need to change your asset allocation.

What may be the best suggestion of all – and it doesn’t cost anything – is simply this: Don’t check your portfolio value too often. Some experts advise reviewing your holdings once a month; some would say once a quarter is plenty. Although past performance may not be indicative of future results, remember, despite wars, recessions, scandals, and various other events over many decades, the long-term price trend of U.S. equities has been up and stocks have rewarded patient holders quite well.