Finding a bit more to save
Cut a pie into 100 slices and what do you have? Barely a nibble. Seemingly an inconsequential share of anything, 1% can actually make a tremendous difference to your financial security. Even fractions of a percent added to investment returns over time can redefine your life in retirement or your net worth.
For instance, if you can increase your average annual investment return from 5% to 6%, that bump represents a fifth better return – and a substantial increase in your options for living.
Let’s assume that you saved well over your career. You’re 65 now and, in addition to your Social Security benefits, you have $500,000 that may need to last 30 years. A 5% average annual return – reduced 2.5 percentage points for projected inflation – allows you to withdraw $1,750 pre-tax each month and enjoy, considering average longevity, an excellent probability of not running out of money for the rest of your life.
Increase your average annual return to 6% (make it 3.5% after inflation) and you can increase monthly withdrawals to $2,000 while maintaining significant probability of stretching your nest egg to age 95.
Sounds great – except that adding a percentage point to your expected returns without accounting for more fluctuation in your investment outcomes is hard given today’s low yields for bonds.
For the past 30 years, many people lived well in retirement off bond-heavy portfolios. As interest rates trended down for a generation, bond returns were adequate to exceptional.
We are exiting the golden age of bonds. Now global interest rates are near all-time lows and investors find bond returns inadequate to generate enough retirement income.
Bonds saw multiple decades of weak returns years ago, but most retirees then had both shorter life expectancies and company pensions instead of an investment account. Retirees saw far less reason to squeeze a little more return out of money.
With low bond income, many investors feel compelled to seek more investment return via more money in the stock market or high-yield junk bonds that may deliver better returns and higher income only in exchange for more uncertainly and volatility. Risk of bond issuers’ default, aka credit risk, is tame right up until it isn’t – sometimes also the moment that some investors ignore issuers’ questionable credit quality while scrambling for that extra point.
So how can you walk that narrow cliff trail between risk and earning slightly more? First, focus on what you can control. Though this task obviously doesn’t include investment outcomes, you can learn much more about your exposure to risk, reasonably expected returns and how both match your goals.
A written investment policy (aka an investment policy statement) tied to your financial plan can add a guardrail to that cliff edge, minimizing your emotional and knee-jerk decisions when the market turns temporarily sour.
Another avenue of risk-free return: Lower your investing expenses. Understand the management fees of funds you own – and your alternatives. In some cases, particularly if you save via a small-employer 401(k) or 403(b) retirement plan, you might realize a full point through cost savings if you roll your money over into a less-expensive individual retirement account.
You can also just save more before you need to start living off your savings.
Working an extra year before you retire can reduce a lot of your reliance on investment outcomes. Not only will an extra 12 months of savings (and one fewer year of retirement income withdrawals) help, you also pad your imminent Social Security income – the best risk-free investment you can make.
And as always, find ways to reduce spending without reducing your quality of life. You might be surprised at how easily you can spare just a hundredth of your money.
MORE: Not the time for bond funds
MORE: Do you fear risk or loss?
MORE: Surviving money droughts
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Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, and a registered investment adviser in Tacoma, Wash. Find risk tolerance resources at his blog The Money Architects, where an expanded version of this piece first ran.
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