The statistics about retirement savings are pretty sobering. The Employment Benefit Research Institute has found that more than half of Americans have saved less than $25,000. AARP reports that half of Baby Boomers doubt they'll ever be able to retire.
The problem of little or no retirement savings is a front-burner topic. What is less discussed is how to make the money you have saved for retirement last. Since you don't really know how long you will live you don't really know how much you'll need. But Jane Bennett Clark, senior editor at Kiplinger Personal Finance, says you'll probably need more than you think.
“With increased longevity you could end up living 25 to 30 years into retirement so you really can't afford to ignore the effects of inflation on your buying power of your retirement savings over several decades,” Clark said. “So in order to beat inflation you have to invest some of your savings for growth and that means investing in stocks.”
Rule number one
In a recent article she profiled a couple who retired around the time the bottom fell out of the economy in 2008. They watched in horror as the value of their retirement account portfolios plummeted. However, they held on and didn't sell, meaning they caught the upside when the market bottomed in March 2009 and the Dow Jones Industrial Average more than doubled. Her number one rule? Don't dump stocks.
That's not the same as the “buy and hold” strategy, however. If a fund or individual stock is performing poorly there's no reason not to sell and move the money into another fund or stock. Just don't panic and sell into a bear market because they are usually followed by bull markets.
Clark thinks a good general guideline for people entering retirement is to keep a ratio of 40% stocks to 60% fixed income. With interest rates and bond yield tiny over the last five years dividend stocks have increased in popularity. These equities pay shareholders a dividend each quarter, many the same or much higher than bond yields. But Clark sees some dangers.
Be careful with dividend stocks
“Dividend stocks are becoming expensive so you have to be picky about what you're getting,” she said. “Also, stocks can fall when interest rates finally do rise.”
And “expensive” doesn't strictly apply to the price, but rather the price in relation to earnings. An “expensive” stock is one that sells for a high multiple of its earnings per share – a multiple that might not be justified by its prospects for future growth.
Figuring out what's expensive and what isn't takes some time and effort, which is why most retirement accounts are made up of mutual funds. These funds are professionally managed with fund managers deciding when to buy and sell the stocks that make up the fund.
Stock guru Jim Cramer recently criticized the typical 401(k) plan for what he called a lack of attractive options for investors. He has always been a a proponent of owning individual stocks – but only after the investors takes the time to learn the ins and outs of investing.
Are you a stock picker?
“I don't think most people have the interest or the time or knowledge to track individual stocks and be stock pickers,” Clark said. “If you like to do it, great. But I think mutual funds are the logical choice for most people.”
Even if your investments are exclusively in funds, Clark says some are conservative and some are more growth oriented. She suggests spreading your money around in both types, in what she calls the bucket system.
“You invest enough money in liquid, conservative accounts to cover several years worth of basic costs,” Clark said. “Then you might create another bucket with investments that give you more potential for yield and that would cover some of your discretionary expenses. And then a third bucket would be for growth investments.”
Stepping up savings
As Baby Boomers approach retirement and worry that they don't quite have it covered, are there things they could be doing to help them sleep better at night?
“The obvious answer is they can be saving as much as possible, including taking advantage of their catch-up contributions to their 401(k) and Roth IRA,” she said. That's a really good opportunity to pile money into their tax deferred accounts.”
Individuals who are 50 years old at the end of the calendar year can make extra “catch-up” contributions to their retirement accounts. The Internal Revenue Serice (IRS) explains it here.