Can This Retirement Be Saved? Case Study Age 40
December 17, 2012When I was a kid, I used to love to read the Redbook magazines my mother had lying around the house. My favorite column was “Can this marriage be saved?” since it gave the wife’s point of view, the husband’s point of view and then finally the therapist’s point of view of the marriage and what could be done to improve it. I realize I am like that therapist now but for finances.
The most common question I have been getting from employees is “Am I on track to retire?” But another way of asking it is, “Can my retirement be saved?”
Let’s take a look at a recent example:
Last week, I met with Mark (*not his real name) who is in his early forties, makes a six figure income and is saving 12% of his income including his employer match. He figured he’d be on track to retire at 66. When we ran a retirement estimate, he only was on track to replace 50% of his income. Cutting his salary in half at retirement wasn’t very appealing to him so we looked at what he was doing and how we could improve it.
What we saw was that there was nothing wrong with Mark’s contribution rate but his investment allocation was extremely conservative for someone 26 years from retirement. His main concern was market fluctuations so he had put the majority of his existing balance in the stable value fund which paid less than 3%. This gave him stability but not the long term growth he needed to meet his retirement goal. However, we found that if he could earn just a 2% higher return over time, he would be on track to replace 80% of his income in retirement instead of the dismal 50%. Since he had so many years to go, even a small increase in average returns made a monumental difference in his retirement.
How can you get a slightly higher return?
Reduce your fees. The average mutual fund has expenses of 1.2-1.4%. Index funds, exchanged traded funds and low fee mutual funds can often save you a ½ to 1% a year in fees! Check the expense ratio of your mutual fund to make sure you are choosing the options with the lowest fees.
Tweak your investments mix. Make sure your investments are appropriate for not just your risk tolerance but also for your time frame. Even conservative investors who have a ten year time frame benefit from exposure to equities. In this risk tolerance profile and asset allocation worksheet here, a conservative investor still maintains a 30-40% stock exposure and a moderate investor maintains 50–60% in equities.
Tweak your mix of investments to set yourself up to squeak out a higher weighted average. Look over your investment mix and enter your asset allocation into this weighted return calculator (click here). For example, investing in 100% treasury bills (which would be similar to the stable value fund or a money market) would have historically given you a 3.6% overall return. If you moved 20% to large company stocks and 10% to mid-size company stocks but left 70% in treasuries, your weighted return historically would have been 5.6%.
That is 2% higher! There is your difference while maintaining a conservative allocation.
Invest new contributions more aggressively. Consider allocating 100% of the contributions from your paycheck into equities. This way when the market fluctuates, you take full advantage of the dollar cost averaging strategy (click here for article on dollar cost averaging.)
In our example, we were able to save this retirement and get him back on track with some fairly minor tweaks. We enhanced his returns by reducing fees and tweaking his investment mix slightly but remaining conservative so he wouldn’t abandon the strategy in times of economic turbulence. So all in all, we can say, “yes this retirement can be saved.” How nice is that?