More Americans will reach retirement age over the next two decades than at any other time in this country’s history. Unlike their parents who relied on traditional pensions, boomers will be the first generation whose principal retirement assets will come in the form of a lump sum, such as a 401(k), IRA, or SEP account. According to the Employee Benefit Research Institute, it is estimated that boomers hold over $1.75 trillion in 401(k) plans. A large number of these new retirees will be facing retirement without the benefit of a pension, relying almost entirely on their savings and 401(k). However, these nest eggs are vulnerable to unwise spending, bad investments, and legal judgments that could arise out of litigation claims or catastrophic health care expenses.
If conventional investment strategy is employed many new retirees will outlive their savings. The typical financial planner would base his or her client’s allocation of investments on the Rule of 110. By subtracting a client’s age from 110, the difference provides a rough guide for how much should be allocated to higher risk investments such as stocks. However, the actual individual deployment of funds needs to be based on investment objectives, financial needs and the client’s level of sophistication. Alternatively, a typical withdrawal strategy tends to follow the simple rule of thumb of 4 percent of assets a year.
Generally speaking, the longer the time horizon, the more risk can be incorporated into a financial plan. Investors are rewarded with a higher return in stocks because over the long term stocks have significantly outperformed other investment securities. Consequently, there is more risk in owning stocks if one has a short-term time horizon. Time exerts a different effect when analyzing the risk of owning fixed income securities, such as bonds. More risk is associated with holding a bond for a long period of time because of the uncertainty of future inflation and interest rate levels.
Retirees face an entirely different zone of inflation risk than working couples. Retirees face inflation rates weighted to a greater degree by medical costs, which have been rising at a rate of 12 percent or more per year. An adjusted inflation rate as low as 6 percent would mean that goods and services would double in cost every 12 years. For a retiree on a fixed income, such stratification of inflation would be devastating. Given these factors, most simplified investments strategies are likely to fall short in meeting a couple’s retirement needs, leaving many retirees destined to live financially strapped lives.
Peter Klein is the director of life settlements at Capitas Financial. He can be reached at email@example.com.