If you&ve counted on perpetual high returns to fund your nest egg, it&s time to rethink your financial future.
If you've counted on perpetual high returns to fund your nest egg, it's time to rethink your financial future.
So much for calculating retirement income based on double-digit returns every year. That pipe dream is over. "People made absurdly optimistic projections, expecting the bull market to last forever," says Don DeWaay, a financial planner in West Des Moines, IA.
If your estimate of returns is off, the amount you end up with could be way off. Say you have a $200,000 stash and are counting on a 14 percent annualized return to give you a $1.6 million nest egg in 15 years. If your annualized return is only 8 percent, you'll wind up with less than half that.
Some analysts are confident that stock prices will rebound. Many others, though, predict milder returns for the coming decade. The recent bull market was an aberration, they say: Although the Wilshire 5000 Indexwhich includes all US common equitiesreturned an average of 27.1 percent annually from 1995 through 1999, the index averaged only 8.8 percent annually in the prior five years.
"In coming years, annual returns are likely to be a lot closer to that 8.8 percent figure than to what we've seen in the last few years," says Mark Vitner, an economist with First Union in Charlotte, NC. "I play it cautious and calculate yearly returns on my own retirement account at 8 percent."
Why the conservative prognosis? For one thing, investor sentiment has soured. "Money poured into the market, which became overvalued and was ready for a fall," says A. Gary Shilling, an economist in Springfield, NJ, and author of Deflation: Why It's Coming, Whether It's Good or Bad, and How It Will Affect Your Investments, Business, and Personal Affairs. "In 2000, many investors got burned and learned that the market had a downside. Some are selling stocks at a loss, and others will no longer leverage in order to buy stocks. Many are getting more serious about increasing their savings, which will help promote deflation."
Adds Vitner: "It's going to get tougher for companies to aggressively grow sales. I foresee continued pressure on profit margins, higher energy costs, and tech companies with less access to capital."
Moreover, the gross national product and consumer spending have declined in the past year. And the Fed's recent interest rate cuts haven't boosted prices back to previous highs.
Even if the market bounces back again soon, more potholes will likely develop down the road. "The market may also fade toward 2010, when the first of the baby boomers turn 65, retire, and start to withdraw savings," says DeWaay. Widespread retirements will lessen the flow of money into the market through 401(k) plans.
If you've based your retirement plan on an 8 to 10 percent annual return, you're probably safe. If not, recalculate and see where you stand. Ask your financial planner for help or use one of the Web-based financial calculators. (A good one is at www.rmbank.com/calculators/retire.asp.)
What if it appears you'll fall short of your target? "Unless you're willing to work longer, accept greater investment risk, or live more modestly in retirement, the only viable option is to save and invest more," says Stewart H. Welch III, a financial adviser in Birmingham, AL.
But simply investing more won't do the trick if you don't do it right. Here's how to keep your portfolio pumping in a slowed-down market:
"The recent market decline provided a great reality check," says Marc Singer, a financial adviser in Coral Gables, FL. "It's time to make sure you have a plan that can accomplish your goals."
You need a clearer target than "I want my money to grow." Figure out how much you want, when you'll need it, what returns will enable you to attain that amount, and how much risk you'll have to take.
"Those elements will help you develop an efficient portfolio, meaning one that takes only the risk necessary to achieve the desired returns," says Welch. "If an 8 percent return will get you where you want to go, why incur greater risk?"
See how your existing assets fit your plan. Consider the assets in all of your accounts; you may have money in old IRAs, a 401(k) plan from a prior employer, or taxable accounts. Identify the amount you need for emergencies and upcoming expenses such as new cars or college tuition. Evaluate the remaining assets, to see how they add to your portfolio. If you have mutual funds or investment accounts with many companies, consider moving them into one brokerage, so you can review all your investments at once and easily measure your total return.
Even if you've got the incredible shrinking portfolio, don't avoid equities. It's tempting to retreat into bonds, money-market funds, and certificates of deposit, but in the long term, you'll be underfunded. "As retirement vehicles, CDs and money-market funds are actually quite risky," says Singer. "After taxes and inflation, the real rate of return is typically 1 percent or less. If retirement is more than 15 years away, at least 60 percent of your portfolioperhaps as much as 80 percentshould be in equities."
Don't try to time the market by pulling out when you fear a price dip. Even the experts can't predict when bull and bear markets will end, and you're liable to miss a growth spurt. If stocks rise, you'll have to buy shares at a steeper price.
Still, don't hang on forever to dismal stocks or funds. If a holding's performance is consistently way below average for its category, unload it.
Some folks got giddy over soaring tech stocks, loaded up, and watched their stashes shrivel when the market sank. You can avoid a similar experience by spreading out your investment dollars.
Invest in market segments that don't move in sync. "Diversification limits your upside, but more important, it protects you on the downside," says financial adviser Welch. In a long-term slow market, you can't afford to let one sector drag you down, because there may not be a bull market to yank you up.
Unless you plan to devote significant time to following your portfolio, stick to mutual funds. If you're buying individual stocks, you need 16 to 20 to get sufficient diversification; with funds, you may need just a handful. "If you have significant holdings, you can achieve reasonable diversification with an international, a large-cap, mid-cap, small-cap, and a real estate mutual fund," says Karl Graf, a financial adviser in Wayne, NJ. (Large-cap, mid-cap, and small-cap funds invest primarily in companies that have market capitalizations of over $5 billion, $1 billion to $5 billion, and less than $1 billion, respectively.)
"To further reduce risk, divide each equity segment into value holdingsthose that are overlooked and are in a temporary slumpand growth," Graf adds. If several of your funds have the same objective, such as aggressive growth, you may want to switch one or more to a different asset class or concentrate newer holdings in more conservative funds.
Small-cap mutual funds had annualized five-year returns of 9.6 percent through March 31, while large-cap funds returned 11.6 percent. Value funds returned 11.6 percent, and growth funds returned 10.4 percent; in 2000's market, value funds returned 10.2 percent, while growth funds returned a miserable -9.8 percent.
International markets provide an additional measure of diversification. Different factors affect different countries' economies at different times, although some markets, such as Canada's, have a greater correlation to ours than others.
Check to see whether you still have the desired percentage of assets invested in each market sector. If one group has soared and become too big a force in your portfolio, move some of that money into lagging segments. Before selling profitable shares, however, make sure you've held them for at least 12 months, so you'll be taxed at the capital gains rate, not at the higher ordinary income rate.
"People may question the wisdom of rebalancing," DeWaay says. "If one sector's lifting your portfolio, they ask, why not let it run? But rebalancing prevents a crash that could occur when one sector dominates. Diversification is no less appropriate just because one group heats up."
Besides restoring the market segment mix, review the split between equities and fixed income. The proportions that you found acceptable at age 45 might be too risky for you at age 55.
As many investors have learned recently, the price you pay for a stock matters, and so do profits. Many companies are good to own if you can pay a reasonable price for them. But if you must shell out top dollar, that could limit your ability to profit.
Stick with companies that have earnings, and check their price-earnings ratios. A company's P-E gives you an idea of how much you're paying for its earning power. Often, a premium P-E ratio indicates that investors believe the stock price will rise. Keep your eye on solid companies, and buy them when their P-E ratios decline, which many have recently.
Look for a ratio that's lower than the company's earnings growth rate. That will give you an efficient company with increasing earnings. Choose a company with a growth rate that's stable or increasing. And stick with companies whose earnings have grown at least 12 percent annually over recent years.
If you're investing through mutual funds, make sure they're what they claim to be. Read the prospectuses, and check periodically to make sure the funds follow their declared styles. Some portfolio managers drift from their mission, and you could end up with a much riskier fund than you intended.
Need to invest more, but don't know where you'll find the cash? Squeeze harder. Start by tracking your spending for at least three months, which will give you a fix on where your cash is going. The information can give you a better handle on opportunities to cut down.
List your expenses in these categories:
Nondiscretionary expenses, including basic clothing, car, child care, food, gas, electricity, laundry, medical care/drugs, telephone, water, home mortgage or rent, other mortgages, real estate taxes, real estate maintenance fees, household repairs, maintenance, sewerage, garbage collection, auto insurance, disability insurance, health insurance, homeowners insurance, life insurance, other insurance, dues, license fees, fees for legal or other professional services, bank loans, other loans, and support for dependents.
Discretionary expenses, including additional clothing, beauty care, charitable contributions, credit card interest and fees, entertainment, household help, newspapers/magazines, optional health care, private school, recreation, and vacations.
Better yet, use personal finance software, such as Quicken or Microsoft Money, which will automatically track all your expenses by category.
Don't neglect to save on the cost of debt. If you've got hefty credit card balances at high interest rates, paying off that debt with a home equity loan might free up more cash for savings. Also, set up an automatic investment plan. Many mutual funds will make arrangements to deduct a preset amount from your bank account each month.
You may need to make lifestyle changes to find savings. That could entail taking more-modest vacations, keeping your car longer, or downsizing to a smaller home. Some moves could be painful.
"Try to create a clear and detailed picture of what you want retirement to be like," says Karl Graf, a financial adviser in Wayne, NJ. "If you can envision why you want to get more money for your future life, it becomes a powerful motivator."
Diversity is the key to a sound investing strategy. Exactly how you slice your own pie will depend on your age, risk tolerance, and time to retirement.
Marc Singer, a financial adviser in Coral Gables, FL, advises keeping as much as 80 percent of your portfolio in equities if you have at least 15 years until retirement. Don DeWaay, a planner in West Des Moines, IA, is more conservative, recommending about 60 percent. Decide how far along you are to your retirement goals, how much cushion you have, and how much risk you're willing to assume. Keep the "safe" portion of your portfolio in bonds, certificates of deposit, and Treasuries.
Upon retirement, you probably want about 50 percent of your money in the market, and the rest in fixed income. Remember, you may live 30 years in retirement, and you need investments that will keep growing.
To construct a portfolio that's likely to perform well even when the market's plodding, choose funds with long-term returns that indicate strong performance prior to the recent bull market.
Consider dividing the equity portion of your portfolio among the groups shown below. In each group, we've included some of the highest-returning funds over 10 years.
Leslie Kane. Keep your portfolio pumping in a slowed-down market. Medical Economics 2001;9:38.