Humans have a long history of accepting misconceptions as facts: the myth that the earth sat at the center of the universe began with the ancient Greeks and endured well into the Middle Ages. Even today, common myths (Thomas Edison invented the light bulb, for example) are regarded by many as “facts.”
Given the tendency that society accepts misguided and unfounded ideas as truths, it isn’t surprising that investors often have misconceptions about investing.
Surveying our industry, I see three widespread myths that threaten the financial health of investors, particularly those on the cusp of or in retirement.
Myth 1: Reaching “a Number” Is Enough
Many retirees falsely believe the myth that reaching a magic number in retirement savings – often a seemingly large round number like $1 million – will ensure their needed retirement income. In reality, the focus should be on a more robust metric such as the Funded Ratio, which considers both the assets an investor has as well as their liabilities. These liabilities are the projected cost of their future spending based on their spending goal, age, marital status and inflation expectations. The Funded Ratio opens the door for the advisor to have a very personal conversation about the client’s situation.
Myth 2: More Equities Fixes Overspending
While increased equity allocations could help clients spend more in retirement if markets are good, some investors ignore the associated increase in volatility, therefore introducing sustainability risk to their portfolios. If markets aren’t favorable, increased equity exposure could be catastrophic for clients’ retirement plans.
Future results are never certain, so individuals that have a higher equity allocation, especially once they are already in retirement, may often find themselves even worse off than if they had kept a more conservative allocation. We believe that advisors should use customized retirement income projections to illustrate the results of various asset allocations, and then help clients choose allocations that fit their spending habits and capacity to bear market risk in addition to their psychological risk profiles.
Myth 3: Retirees Should Never Invade Their Principal