In recent years, there has been much focus on financial literacy and on teaching how to start saving and investing, especially for retirement, but little focus on what may be called “retirement literacy,” or the understanding of the basic principles of how to manage money once in retirement.
Without sufficient retirement literacy, millions of Americans will unnecessarily end their lives in financial deprivation. They will be unable to make effective decisions in crucial areas such as how to spend prudently each year in retirement, and how to do asset allocation once retired, even when enough money has been accumulated.
Clear evidence exists that current levels of retirement literacy are quite low. Many people know, for instance, that saving early makes sense because a dollar invested in 2009 will be worth a great deal more in 2034. Yet most do not understand that a dollar spent in 2009 means having a great deal less in 2034.
Many people even misunderstand the simple concept of life expectancy. Consider: one research subject said, “I do not want to take a chance of running out of money, so I am planning to have enough to last until my life expectancy.” Apparently he, like many others, did not know that people have about a 50% chance of living beyond average life expectancy if in average health for someone their age, and an even higher chance if healthier than average.
When it comes to asset allocation, some people, even some financial advisors, look at the income phase of life as a basic continuation of the accumulation phase. (The income phase refers to the period after people retire and need to fund their lifestyle with money they have accumulated.) These people use the same products and strategies during the income phase as they did during accumulation, or a slightly different strategy that glides gradually to a lower exposure to equities.
What they need to know is that the income phase is significantly different than the accumulation phase. Here are some key areas of difference:
Target dates. During accumulation, people typically have a target for when they want to retire, such as age 65. They save for it, but the penalty for not having saved enough when the target point arrives is generally not high, since many then decide to work longer. However, after retirement actually occurs, there is no longer a fixed target and the penalty for missing the target (e.g., running out of money) becomes very high. That has considerable implications for financial strategies. Most retirees do not have effective systems for dealing with the intrinsic uncertainties about the length of the period for which income is needed.
Market movements. Accumulators benefit when the market goes down because they can buy low. But those in the income phase suffer when the market goes down, because they are often forced to sell low. That makes a big difference. This too has important implications for investment strategy.