10 Steps to a Perfect Retirement
Reprinted courtesy of MarketWatch.com.
To read the original article click here.
For most investors, the end goal is a successful and satisfying retirement.
Here are 10 things you can do to maximize the “gold” in your golden years.
One: Know how much you’ll need to retire
This number is a key that helps unlock some mysteries, such as how much risk you should take and when you’ll be able to retire.
Here’s how to do it. Figure out your essential living costs, the rock-bottom amount of monthly cash flow you need to sustain you. Only you can determine this number.
From your answer, subtract the monthly retirement income you can count on such as a pension (if you are lucky enough to have one) and Social Security. What’s left is an income “gap” that you will need to fill by withdrawing money from your investments.
Compute this “gap” as a percent of your portfolio value. If your investments are worth $500,000 and you need $30,000 a year from them, that’s a withdrawal rate of 6%. Any number higher than 4% puts you at risk for running out of money after you retire. So if those are your numbers, you know your portfolio isn’t big enough yet to meet your needs.
Here’s a rule of thumb: You may be ready to retire when your portfolio equals 25 times the annual income you will need from it. If you need $30,000, your investment portfolio should be worth at least $750,000.
Two: Know how much you’ll need for the retirement you’d like
Do the same calculation based on a higher living standard that you would prefer, one that includes travel, golf, hobbies, being generous to your family — whatever would make your retirement especially worth looking forward to.
You’ll wind up with a larger “gap” in this calculation.
If you want $60,000 a year from your investments, they should be worth at least $1.5 million.
Three: Determine your tolerance for risk
This is probably the most critical — and most neglected — step in retirement planning. Investors are paid to take risks; you won’t get rich on any investment that most people regard as a “sure thing.”
But this doesn’t mean you need to speculate. Later in this list I’ll give you a tool for determining your risk tolerance.
Four: Base your decisions on what’s probable
Base your decisions on what’s probable — not what’s merely possible. This means, for example, that buying lottery tickets isn’t a sound investment.
Over the past few years the market has been quite favorable to investors. Last year, the most popular stock indexes gained more than 30%. But that’s abnormal. A much more realistic expectation for the next decade or so would be stock gains in the upper single digits. Hope for the best if you like, but plan for less exciting returns.
Five: Invest in asset classes likely to deliver over the long haul
Invest in asset classes with the highest probability of producing favorable long-term returns. Fortunately for you, I have already identified those asset classes, which are incorporated in mymutual fund and ETF recommendations .
Here they are: In the U.S., large-cap stocks, large-cap value stocks, small-cap stocks, small-cap value stocks, REITs; and internationally, large-cap stocks, large-cap value stocks, small-cap stocks, small-cap value stocks, and emerging markets stocks.
Late in 2012, I described how to use this information to beat the market.
If you diversify among asset classes like these, you won’t get snookered — like so many people do — into putting all your trust in whatever has been performing well recently.
Six: See previous column
Use my previous article to determine the best combination of assets for you, especially the percentage split between stocks and bonds. This is the tool to help you with risk tolerance.
The article includes an updated table showing historical return and risk information for 11 combinations of stocks and bonds, going back to 1970. I have been using this table for many years to help investors find the mix that’s right for them.
Seven: Keep your expenses as low as possible
Think of your portfolio as a sailboat trying to move forward, and expenses as an anchor that’s being dragged behind. Even if you have a great wind and a terrific crew, that anchor slows you down. The bigger the anchor, the slower you go.
Avoid, whenever possible, one-time expenses such as sales commissions on mutual funds and other products. In effect, they force you to start sailing back behind the start line.
You’ll need to pay ongoing management fees, but they can eat into your returns and slow you down. In fact, they put you at a disadvantage right from the start.
Compared with typical actively managed funds, this simple step can literally put millions of extra dollars in your retirement portfolio. If you remember the calculations from the first two steps above, you know how valuable that is.
Eight: Pay as little as possible in taxes
This is a variation of the last point.
As much as you can, invest in accounts that are tax-advantaged such as IRAs and 401(k) and similar employee plans. Roth versions of these accounts aren’t available to every investor. But if you can use a Roth IRA or a Roth 401(k), they are great vehicles for earning tax-free gains.
In taxable accounts, consider tax-managed funds (Vanguard has some excellent ones), commission-free ETFs and (if you are in a high tax bracket) tax-exempt bond funds.
Nine: Put your investments on automatic
There’s no reason you need to decide to save every time you get a paycheck. Sign up for payroll deduction. Index funds will automatically (and inexpensively) keep you diversified.
If your plan calls for periodic rebalancing between stock funds and bond funds, sign up for automatic rebalancing. Many mutual fund companies and advisers will do this for you at no charge.
And when you’re withdrawing money (see my final point below), make your withdrawals automatically so you don’t have to decide every month or every quarter how much you’re going to take out.
Ten: Determine the best strategy for withdrawing money from your portfolio
This can be tricky, and you will probably benefit from sitting down with a professional adviser to make sure you understand the decisions you make and their ramifications.
There are a lot of moving parts included in this step. How much will you take out each year? Will your withdrawal amount be fixed or variable from year to year? How long do you expect to live? How much do you want available at the end of your life for your heirs? Do you expect to need more money in the early years of retirement for travel and other activities you might not be able to do later?
This step will make such a big difference to the rest of your life that I’ve written a couple of good articles on the topic. One shows how to make your nest egg last over 40 years. The other one I call “The ultimate retirement withdrawal strategy.”
Richard Buck contributed to this article.