Investing Retirement Funds, Inflation and Longevity

We're getting older as a nation and having to depend on ourselves more and more for funding our retirement years. If you're somewhere between 18 and 80, you should pay close attention to what the following article and accompanying charts have to contribute to the discussion.

Making Your Retirement Assets Last is subtitled 'Retirees want to make sure their portfolios survive as long as they do. Here are steps that can help.'  Here's what the article says in pertinent part:

"It's a retiree's nightmare: outliving the assets in a retirement portfolio.

Between historically low interest rates dragging on fixed-income yields and uncertainties about taxes, not to mention the threat of future inflation and volatile markets that send skittish investors seeking shelter, retirees who are living longer are finding it challenging to keep their portfolios up to speed.

Recent calculations from the Employee Benefit Research Institute show that roughly 44% of those born between 1948 and 1978—baby boomers and Generation X—won't have adequate retirement income, and that is assuming interest rates go back up in 2014. But the current environment is weighing even on those heading into retirement with what seems like a tidy sum.

Retirees need an efficient plan of attack to squeeze all the juice out of their portfolios, ensuring they have sufficient assets for their golden years. Here are some strategies:

Dedicate dollars for fixed expenses.

 Retirees should map out a budget for necessities—include everything from housing to food, transportation, health expenses and utility bills—and set aside a chunk of a portfolio for these costs.

Many planners suggest putting funds to cover three to five years' worth of expenses into safe and liquid vehicles, so the retiree has cash on hand, even if the market drops.

"That way you don't have to liquidate in a down environment," says Marty Leclerc, portfolio manager for Barrack Yard Advisors in Bryn Mawr, Pa.

Even though money-market funds are returning basically nothing, funds earmarked to be used within three years should go into these instruments, says Michael Gibney, a financial planner in Riverdale, N.J. "There is no reason to put money that will be used within a short time period at risk," he says.

For five-year time frames, look to add in a short-term bond fund or certificate of deposit to gain a little more yield, he says.

Watch out for longevity risk.

With many people living well into their 90s, retirees need to think carefully about how to protect themselves from running out of money in their later years.

(Longevity calculators that factor in your family history and current health can be found at websites such as gosset.wharton.upenn.edu/mortality and livingto100.com.)

Some financial advisers say retirees should consider long-term-care insurance as a hedge against the future cost of nursing-home care, which has the potential to decimate even hefty nest eggs.

With 70% of people over age 65 running into some type of health problem that could necessitate some form of long-term care, it's a big expense that many retirees initially forget about in planning, says Robert Stammers, director of investor education for the nonprofit CFA Institute.

Critics say long-term-care policies can be pricey and may have limits on the benefits they pay out, so retirees need to make sure they understand what they are getting before buying. The average annual cost of such a policy for a 57-year-old single individual is about $1,900, while a couple of the same age would pay about $2,500, according to the American Association for Long-Term Care Insurance, an industry trade group.

Annuities are another long-term planning tool that can provide a steady stream of income in later life, and a relatively new type of annuity known as longevity insurance is gaining in popularity.

Longevity insurance is similar to an immediate annuity in that it allows holders to take a lump sum and convert it into a lifelong income stream. It is different in that it requires policyholders to pick a date in the future to start getting that income, typically at age 85, says Christopher Jones, chief investment officer at investment adviser Financial Engines Inc.

This guarantees a retiree won't outlive a portfolio, some advisers say, plus delayed payments are typically larger than those from annuities that allow policyholders to start collecting money immediately.

"It takes a problem that has this uncertain length and turns it into a certain horizon," says Mr. Jones.

Don't be too conservative—bonds aren't always your friends.

Advisers warn against falling victim to traditional wisdom: Portfolio protection through conservative investing in retirement could actually do more harm than good.

With bonds not generating enough income, "the math is scary," says Mr. Leclerc. "Retirees need a lot more money than they ever thought they would to produce simple income."

Retirees looking to generate more yield may be tempted to buy long-term bond funds, but advisers warn against locking in an investment now that could be disastrous when interest rates eventually start to rise. When rates rise, prices fall, so your principal would take a hit.

"So-called safe assets are paradoxically not safe right now," says Mr. Leclerc.

Some advisers suggest intermediate-term bond funds as a way to help mitigate interest-rate risk, while still getting more yield than what's available from short-term bond funds. . . .

Don't forget about inflation

Although inflation hasn't strayed far from the historical average of 3.2% annually in recent years, advisers says retirees can't ignore this "silent killer."

"When clients come in, it isn't the first five to 10 years that projections look bad, it's the second half of their retirement where they get beat up," says Frank Fantozzi, a Cleveland-based financial adviser.

To protect themselves, retirees should add to their portfolios multiple types of assets that can keep up with or even beat rising costs. Still, many advisers maintain that the best way to combat inflation in a well-diversified portfolio is by investing in equities.

"It's the only asset class that will give them returns greater than inflation," Mr. Gibney says."

Summing Up

It's never too early to start setting aside money for retirement. And if stocks are the preferred investment, the longer the time money is invested in equities the better. In fact, experiencing the inevitable ups and downs of market cycles will help you stay the course, when the ride gets rocky.

One truism is that we experience much less joy when our investments do well than the discomfort and even pain we undergo when times are tough.

Another truism is that over any 30 year timeframe, bonds have never outperformed stocks.

And yet another is that stocks are the only real effective inflation hedge over time.

For all these reasons and more, set aside money early and dollar cost average as the years unfold.

In the end, we'll be glad we did.

Thanks. Bob.