Editor’s Note: This is the second section of our two part series teaching 27 ways late starters can catch up on retirement savings. Part one taught the first 3 of 6 tactics focusing on traditional ways to catch up on retirement savings. In part 2, below, we will break with conventional wisdom in the final 3 tactics.
Tactic Four: Overcome The Mathematical Limitations To Retirement Savings Through Direct Ownership
The conventional wisdom in retirement savings is to visit your local broker or financial planner and open a retirement account. Then stuff this account with savings from your earnings through a variety of tax deferred and taxable savings vehicles which are invested in traditional paper assets like stocks, bonds and mutual funds. That is the traditional approach to retirement planning, and up to this point that is what Part 1 of this article addressed.
Now it is time for something different in order to start catching up on retirement savings…
The reason you want to consider alternatives to the traditional approach is because later savers are by definition short on time. Conventional retirement planning requires you to have sufficient time and money to make the numbers work. It assumes you can save and grow enough money between now and your retirement date to reach your goals. Unfortunately, for many late savers that assumption is false.
For example, let’s say you earn $100,000 per year, have little savings or significant assets besides your home, and are 55 years old wanting to retire in 10 years. Conventional wisdom says you need $70,000 plus per year in retirement income (70% * 100,000) and Social Security is likely to cover a small fraction of that (30,000 assumed for this example leaving a 40,000 deficit). This would require you to save somewhere in the ballpark of a $1,000,000 (4% withdrawal rate from $1,000,000 equals $40,000) by retirement to make up for your savings shortfall.
(If those numbers went a little fast for you, or you aren’t totally comfortable with the calculations involved, then I highly recommend the ebook “How Much Is Enough To Retire”. It will give you a behind-the-scenes look into retirement planning calculations so that you are able to navigate the numbers with confidence and security.)
Saving $1,000,000 in 10 years is obviously unworkable because it would require someone earning $100,000 per year to save close to 100% of his income every year for 10 years straight. That is not going to happen for somebody who is 55 years old with little savings to date. Sorry, but sometimes reality is harsh.
“Argue for your limitations and sure enough, they’re yours.”
What can you do when the math you face is similarly impossible using conventional retirement planning assumptions? The answer is to change the playing field from conventional paper assets that your broker sells you to direct ownership assets that no broker can sell you.
Examples of direct ownership assets include income producing real estate and owning your own business. These types of assets involve more risk and may have a lower certainty of outcome, but they include leverage principles making aggressive retirement savings goals possible that would otherwise be mathematically impossible with traditional retirement planning.
The key point to understand is direct ownership assets are not bound by the mathematical growth limitations that govern how fast you can build equity in traditional assets. For example, the oft-quoted long-term growth rate for stocks including dividends and excluding transaction costs and taxes is somewhere between 10%-11% depending on time period analyzed and other assumptions. Expected returns for bonds and cash are even lower.
That means late savers should expect very little equity growth in their portfolios because they don’t have enough time to compound that low return rate: the bulk of their savings must be funded directly from earnings. In other words, late savers generally can’t grow their assets to reach their goal using traditional strategies because of the return and time limitations – they must save their way to the goal instead – and that is very difficult for people who don’t already have the savings habit.
Conversely, direct ownership assets like building your own business or real estate portfolio have no upside limit to equity growth because they have multiple sources of return and leverage. You could conceivably start a business (easier said than done) with little or no money down and build it to support a lucrative retirement in 10 years. It is mathematically possible to do this without saving anything from your regular income. This advantage is not available using conventional retirement planning strategies.
Similarly with real estate, I know people who have built a portfolio of properties over a period of years and funded safe, secure retirements in a relatively short period of time through a combination of smart buying, rent increases, and adding value to their properties. Maybe your particular twist would be to convert that old garage on the side of the house into a rental apartment for additional income during retirement, or maybe you’re handy and would enjoy fixing-up dilapidated structures and converting them to long-term rentals.
Others have started sideline businesses to their regular occupation and built them into cash flow machines in just a few years sufficient to support a generous retirement. The options are only limited by your creativity and dedication. What skills do you have that would be fun to convert into a business or real estate empire?
Direct ownership opens up the possibility of achieving aggressive retirement goals when the math governing the traditional approach is all but impossible. It is not an easy path, and it does require skills and involves risks, but a late saver with aggressive retirement goals may have no other viable alternative. It is a choice that should be considered as part of any catch-up retirement plan.
Tactic Five: How Late Starters Can Get More Out Of Their Retirement Savings
Up until this point we have talked about how to maximize your nest egg prior to retirement. The flip side of the same coin is to lower the amount you spend during retirement so that you reduce the savings required. The less you have to save, the easier the goal is to reach. Small differences in spending multiply to huge differences in savings burden.
For example, using the “4% rule” or the “rule of 25″ for every $10,000 less you spend annually in retirement your savings requirements drop by roughly $250,000 (250,000*.04 = 10,000). Many late savers will find it far easier to lower their budget by $10,000 per year compared to coming up with another $250,000 in retirement savings. (See the ebook “How Much Is Enough To Retire” to fully understand these calculations and how they apply to your situation.)
The way you do this is by controlling expenses. Many of the examples cited in Part 1 of this article to help you increase savings apply equally to reducing expenses so they won’t be repeated here. Controlling expenses isn’t just for increasing savings – it is for stretching savings as well. The key principle is that you must get maximum value for every dollar spent. Buying used, eliminating unnecessary expenses, and only spending what you can afford so that you don’t incur consumer debt are always good principles to live by when you’re trying to get more value out of less money.
In addition to the well known and proven dollar stretching methods for consumers there are three strategies that apply specifically to stretching a retirement nest egg for investors.
(1) Control Investment Expenses: Just as you must control your personal expenses, you must also control your investment expenses. The only justifiable investment fees are those that put more money in your pocket than they take out. Few people intuitively grasp the large difference a mere 1% increase in return can make when compounded over 30 years of retirement (10 years of saving plus 20 years retired).
For example, if $10,000 grew annually at 10% for 30 years it would become $174,494. If you increase expenses just 1% giving a net annual return of 9% (10%-1%) it only grows to $132,677 – which is $41,817 less. In other words, if you can add just 1% to return by controlling investment expenses then you can increase the dollars earned by a whopping 31.5% – not just 1%. Amazing!
This is a big deal and can make a meaningful difference in your retirement. The rule is simple: little improvements in return when compounded over time become big differences in the dollar value of your account. Pay attention to that 1% expense ratio by only hiring investment services that add more to your return than they cost you.
How can you capture that 1% or more? Consider how the average mutual fund expense ratio approaches 1.5% annually while low cost alternatives are under .5%. Numerous studies show the high expense funds under-perform their low cost cousins on average. Likewise, many brokers charge 1% annually for their services without any provable value added to return over investing independently at zero cost. These are just two examples of ways you may be able to control your investment expenses by only paying for services that add more money to your pocket than they cost you. Our financial coaching services can educate and support you to implement these strategies and more.
(2) Maximize Tax Advantages: Tax efficiency is also important for your retirement savings. Minimize tax expenses to maximize the value of your savings. For example, if your taxable portfolio includes mutual funds then consider owning competing funds or ETF’s managed for tax efficiency so that you minimize the taxable distributions passed through each year.
“The hardest thing in the world to understand is the income tax.”
Similarly, once you are retired all withdrawals to cover living expenses should be tax efficient. The way you do this is by liquidating your taxable investment accounts first because you have already paid the tax on those earnings. Next in line for liquidation should be non-taxable assets such as municipal bonds. The next-to-last to go should be your IRA’s and other similar tax deferred accounts to maximize the time to compound tax deferred growth. And finally, when all other assets are depleted the Roth IRA should get used up last because it has no minimum required withdrawal age and earnings grow completely tax free.
Finally, when contributing to your retirement savings earlier is better than later. Contributions to tax deferred retirement plans made on the first of the year have one more year to grow inside your plan compared to deposits made on the last day of the year – and it is all tax free growth. Again, this may not sound significant, but over many years it can add up to tens of thousands of dollars difference so it is worth doing. Little details can result in big differences when compounded over many years.
(3) Move to a Low Cost Area: I mentioned this strategy earlier but it’s worth repeating because it can play such an important role in stretching your retirement savings. Consider moving from a high cost of living area like San Francisco, New York, or any other major city or coastal area to a low cost alternative such as the South, Midwest, or even a foreign country. The cost differential can be as dramatic as night and day so don’t dismiss this possibility lightly.
Several things to consider before moving include proximity to family, friends, and important medical providers. Are there other retirees to connect with, and how does the lifestyle fit your retirement interests? Consider visiting the area first and renting for awhile so that you can try before you buy. There are many low cost alternatives for retirement living including moving abroad so try visiting and renting at several until the fit feels just right.
Tactic Six: Redefine Your Retirement Plan For More Happiness and Less Savings
Working after retirement may sound like an oxymoron, but working like crazy for 40 years then spending 30 years doing little or nothing doesn’t make much sense either. For many people a full time career until the magical age of 62 then stopping cold-turkey is an artificially contrived ideal. Reality seems closer to a transitional period of semi-retirement from your 50s through your late 70s (depending on health).
The list of reasons to continue working part or full time after “retirement” is important to consider:
- You want to stay active and relevant.
- You enjoy the personal connection with co-workers.
- You prefer a daily routine to 30 years of unstructured days.
- You want to turn an avocation into a vocation.
- You need to get out of the house and away from your spouse.
- You want to reinvent yourself and pursue a dream career.
- Endless rounds of golf, reading novels all day, and knitting are not your definition of happiness.
- The additional money would be helpful.
“Work saves us from three great evils: boredom, vice and need.”
Assuming you generate $20,000 per year in extra income by working during retirement and use industry standard withdrawal rates of 4% from savings, you will need roughly $500,000 (500,000*.04=20,000) less retirement savings to support the same lifestyle when compared to not working. Clearly, this additional income can be a big band-aid to a late saver’s wounded portfolio.
Before getting excited about this strategy carefully consider if you have the desire to work full or part-time during retirement. Do you want to develop a second or third career that interests you? Maybe you would like to continue with what you already do but just work fewer hours? You can redefine what retirement means to fit your exact needs.
(1) Postpone Retirement: The longer you work the fewer years in retirement you must finance from savings. Not only does this lower the savings required, but it gives more years to continue growing your savings while having your employer cover medical insurance and other expenses. This can dramatically close the retirement savings gap.
In addition, continued work can allow you to delay when you begin taking Social Security which can significantly increase the level of benefits you receive. Similarly, some defined benefit pension plans increase benefits when you remain on the job longer.
(2) Phased Retirement: Rather than stopping work, how about just slowing down? Some employers encourage workers to phase into their retirement by reducing workload to three days a week so that they can retain worker knowledge and skills. If your employer doesn’t offer this program consider switching to a job that offers flex hours or large blocks of vacation time like teaching so that you can slow down without quitting entirely.
Maybe you want to pursue dreams of entrepreneurship in retirement. You wouldn’t be alone according to a study by the Ewing Marion Kauffman Foundation in Kansas City which found Americans aged 55-64 were more likely than anyone else to start a new company. A tried and proven path to entrepreneurial transition in retirement is consulting for your previous profession.
Another popular phased retirement strategy is to convert an artistic passion or hobby interest into extra revenue. What avocations do you enjoy that could be converted into revenue streams? The choices are limited only by your creativity.
Regardless of the part time or second career option you choose, be careful to check first how the additional income will affect your social security benefits and tax situation.
(3) Don’t Retire: Maybe your work is downright fun and so satisfying that you hope to never retire. Consider yourself fortunate. Some people find an active, fulfilling work life beats a life of leisurely retirement any day. If that is true for you, then why fight it? It certainly makes your retirement planning easy.
Retirement Savings No-Nos – Don’t Make These Mistakes
The road to catching up on retirement savings is well trodden. Many have traveled the journey before you and their experience teaches us where the most obvious potholes in the road are located. Anyone trying to catch-up on retirement savings faces certain incentives and realities making them susceptible to making the same mistakes. By learning about these common mistakes and avoiding them you save valuable time and money.
(1) Reaching for Return: Don’t ramp up portfolio risk in a desperate attempt to improve returns. You might luck out and enjoy magnified returns, but the odds favor something worse. Beware of investment scams, speculative stocks, viatical settlement deals, and anything else promising high returns with little or no risk. You are a prime target for investment con-men because of your need for above market returns – so walk carefully. If it sounds too good to be true then it probably is.
(2) Assuming Overly Optimistic Returns: Retirement planning would be a whole lot easier if we could assume investment returns of 15% or more indefinitely into the future – but that’s not reality. Use conservative estimates so that your retirement is secure. Never use aggressive return estimates to force the numbers to work because running out of money in your old age is a tough price to pay for unrealistic assumptions.
(3) Eggs in One Basket: Beware of investing too much of your 401(K) plan in company stock as you near retirement. A single company is much riskier than a diversified portfolio, and you can’t afford the double whammy of losing your job and retirement savings at the same time should your company run into problems. Just ask former Enron employees who were nearing retirement.
You must learn from the mistakes of others. You can’t possibly live long enough to make them all yourself.”
(4) Banking the Inheritance: Many people use an expected inheritance as an excuse to not save for retirement. Life is uncertain. The grantor could spend the inheritance on health care in their final years or make a foolish investment. A lot of things can go wrong to leave you empty handed and destitute in your golden years if you don’t take self-responsibility for your retirement savings.
(5) Don’t Follow Simplistic Guidelines Blindly: Retirement planning is an inexact process despite what all the experts may claim. You are unique with skills, abilities and interests different from anyone else. Your solution to catching up on retirement savings could look totally different from what your broker tells you. Just because he outlines asset allocation and savings requirements doesn’t mean you shouldn’t go build that dream business and invest in real estate instead. It’s your financial security and you are responsible. Consider all options and trust yourself to do what is uniquely right for your situation. You are the only one that has to live with the results.
(6) Invest For A Lifetime: If you are 55 years young and planning to retire at 65, you would be mistaken to believe your investment time horizon is just 10 years. Odds are good you will live at least another 30 years in retirement lengthening your investment time frame out to 40 years or more. Plan your investing accordingly and don’t think too short-term.
(7) More Procrastination: What got you into this bind in the first place is procrastination, and what will get you out of it is doing the opposite. Get pro-active by taking aggressive actions now to catch up on your retirement savings. The longer you wait the harder it will be to catch up. There is no better time to get started than today.
The bottom line is it’s never too late to begin saving for retirement. You still have plenty of options and solutions available to increase savings and reduce cash flow needs – but you must act now. Retirement planning late in your working years may be more difficult, but it can be done regardless of your age if you follow the advice above.
Commit to adopting one or more strategies from this article and begin implementing action steps today. As you get one strategy firmly in place then begin implementing another strategy. Nobody should need or want to adopt all the strategies so pick and choose only the ones that work best for you. Before long you can be well on your way to a secure and fulfilling retirement.
If you would like the support, accountability, and expertise of a personal financial coach to help you sort through these issues then let us know. If you have additional ideas on how late-starters can catch-up on retirement savings then please add to the conversation by participating in the comments below.