MONEY early retirement

How Much Money Do I Really Need to Retire at 55?

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Robert A. Di Ieso, Jr.

Q: I’m 40 and can’t imagine working till I am 65. If I want to retire in my mid-50s, how can I make sure I have enough money to live a comfortable lifestyle?

A: How much you need to put away depends on the kind of lifestyle you want in retirement. A general rule of thumb is that you’ll need to replace 70% to 80% of your pre-retirement income to have a similar standard of living when you retire. So if you earn $100,000 a year, you’ll need roughly $80,000 in annual income. Some of that will come from Social Security (once you reach retirement age) and a pension, if you get one, so perhaps your portfolio will need to produce $50,000 to $60,000 of that income.

You’ll probably need less than your pre-retirement income because you’re no longer socking away a big chunk of your salary for retirement—and if you are aiming to retire early, you should be maxing out all your savings options and more. Your income taxes will likely be lower and many of the costs associated with working, such as commuting and eating lunch out, will disappear.

But if you retire at 55, you’re looking at funding four decades of retirement. That means you’ll need a much bigger cash stash than someone with a standard 30-year time horizon, says Charles Farrell, CEO of Northstar Investment Advisors and author of Your Money Ratios: Eight Simple Tools for Financial Security.

If you work till the traditional retirement age of 65, you should have 12 times your annual household income saved, says Farrell. For someone earning $100,000 a year, that’s $1.2 million (his figures take Social Security benefits into account). But if you want to quit work at age 55 and replace 75% of your income, you’ll need 18 times your annual income or $1.8 million. That assumes a 4% annual withdrawal rate, adjusted for inflation. “Not only does your money have to last longer but as you draw down your nest egg, your savings has less time to grow,” says Farrell.

If you’re not on track, it’s not too late. As you hit your peak earning years and big expenses fall away, such as college tuition for your kids, you may be able to power save, putting away much bigger chunks of money. Or you can adjust your goal. “Maybe 60 or 62 is more realistic than 55 or you can get by on less than you think,” says Farrell.

If you push back retirement to age 62, you’ll need 16 times your annual salary saved. If you really want to quit work at 55 and you’re willing to live on 60% of your pre-retirement income, you’ll need 15 times your annual income. Or if you can get by on 50% of your household income—say you pay off your mortgage or you significantly downsize your home to cut your post-retirement expenses—a nest egg of 12 times your final income may be enough.

Early retirement requires a willingness to stick to a lifestyle that allows you to save diligently throughout your career, while avoiding money drains like high interest rate debt. If this is your dream, it’ll be well worth the effort.

MONEY retirement planning

The 3 Key Numbers To Know for a Successful Retirement

If you start early, it's easier to make your strategy work. Here's how to figure out where you stand.

Retirement calculations are all about the numbers. How big will your nest egg be? How much money will you need to earn in retirement to maintain your pre-retirement standard of living? What type of investment returns should you plan for? How long will you live? Lee Eisenberg even wrote an entire book several years ago about “The Number.”

Let’s restrict today’s numbers to three key figures: 1) the percent of your pre-retirement income you will need to maintain your current standard of living during retirement; 2) the amount of money you will need to sock away to achieve this replacement rate, and 3) how much you can pull out of your portfolio each year and still have a good shot at not outliving your money in retirement.

The Center for Retirement Research at Boston College just issued a study that took a crack at the first two items. It said middle-income retirees should adopt retirement-income targets that would replace 71% of their pre-retirement incomes. To do so, they would need to augment their Social Security and other pensions with contributions to their private savings that would average 15% of their pay if they began saving at age 35 and retired at age 65.

The comparable figures for low-income earners were an 80% replacement rate and an 11% savings rate. This is mainly because Social Security’s progressive benefit structure replaces a higher percentage of pre-retirement income for lower earners. On the other end of the scale, high earners were found to need a replacement rate averaging 67% and a 16% private savings rate.

We could endlessly debate whether these replacement rates and savings targets should be a few percentage points higher or lower. But while some financial advisers may base client strategies on income replacement rates, I have never interviewed a retiree who did so. These numbers are just guides, so don’t get carried away with them.

The big point is that we need to save a lot and to start at early ages. And we’re not saving nearly enough. A second major point of the CRR research is that continuing to work past age 65 can erase a lot of the savings shortfalls for those who haven’t set aside enough.

For example, if that typical middle-income earner doesn’t begin saving for retirement until age 45, she would need to save on average an implausible 27% of her income to permit her to retire successfully at age 65. If she continued working to age 67, that saving rate would fall to a still-unlikely 20%. But if she kept working until age 70, she would need to save a realistic 10% of her salary to maintain her standard living in retirement.

If you have been a dutiful saver, or even if you haven’t, you still need to figure out how to spend down your nest egg. Such discussions often begin with what’s called the 4% rule, which will celebrate its 20th birthday this October.

Developed in 1994 by financial planner William Bengen, it said nest eggs had a good shot at lasting for 30 years if a person began by pulling out about 4%t of their savings in the first year. Whatever number of dollars that represented would determine each successive year of dollar withdrawals plus an adjustment factor to keep pace with inflation.

In a recent study comparing different retirement drawdown strategies, the American Institute of Economic Research said of the rule, “For a rough estimate of how much is needed for retirement, it’s not bad. But no simple financial rule can take into account the complexity of real life.”

Bengen himself says as much. “For most people, to be perfectly honest, applying a 4.5% rule is probably not wise, even dangerous, because there are very simple assumptions that I used to develop that rule,” he said in a radio interview last year.

AIER, an independent non-profit in Massachusetts, ran a slew of retirement spending scenarios that involved variations of withdrawing a constant amount of dollars each year, a constant percentage of nest egg assets or an increasing percentage of assets. This last approach is based on the notion that adverse investment returns are especially damaging during the early years of retirement.

Withdrawing smaller percentages in those early years can help minimize nest-egg depletion (but it would have been scant protection from the Great Recession’s market plunge). You then can afford to withdraw larger percentages in later years primarily because your savings will need to last fewer years as you get older.

After producing nearly 100 combinations of drawdown approaches, dollar and percentage amounts, AIER was refreshingly candid: “There is no winning strategy.” Bad market conditions can ruin even the most prudent drawdown plans. Booming markets can make lunkheads look like geniuses.

Don’t get me wrong. The numbers do matter. But successful retirements, which is what we all really desire, are governed by emotions. I’ll write about these next week.

Philip Moeller is an expert on retirement, aging, and health. He is an award-winning business journalist and a research fellow at the Sloan Center on Aging & Work at Boston College. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

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MONEY IRAs

This Simple Move Can Boost Your Savings by Thousands of Dollars

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Last-minute IRA savers and those who keep their money in cash are paying a procrastination penalty.

Individual Retirement Account contributions are getting larger—an encouraging sign of a recovering economy and improved habits among retirement savers.

But there is an “I” in IRA for a reason: investors are in charge of managing their accounts. And recent research by Vanguard finds that many of us are leaving returns on the table due to an all-too-human fault: procrastination in the timing of our contributions.

IRA savers can make contributions anytime from Jan. 1 of a tax year up until the tax-filing deadline the following April. But Vanguard’s analysis found that more than double the amount of contributions is made at the deadline than at the first opportunity—and that last-minute contributions dwarf the amounts contributed throughout the year. Fidelity Investments reports similar data—for the 2013 tax year, 70% of total IRA contributions came in during tax season.

Some IRA investors no doubt wait until the tax deadline in order to determine the most tax-efficient level of contribution; others may have cash-flow reasons, says Colleen Jaconetti, a senior investment analyst in the Vanguard Investment Strategy Group. “Some people don’t have the cash available during the year to make contributions, or they wait until they get their year-end bonus to fund their accounts.”

Nonetheless, procrastination has its costs. Vanguard calculates that investors who wait until the last minute lose out on a full year’s worth of tax-advantaged compounded growth—and that gets expensive over a lifetime of saving. Assuming an investor contributes the maximum $5,500 annually for 30 years ($6,500 for those over age 50), and earns 4% after inflation, procrastinators will wind up with account balances $15,500 lower than someone who contributes as early as possible in a tax year.

But for many last-minute savers, even more money is left on the table. Among savers who made last-minute contributions for the 2013 tax year just ahead of the tax-filing deadline, 21% of the contributions went into money market funds, likely because they were not prepared to make investing decisions. When Vanguard looked at those hasty money market contributions for the 2012 tax year, two-thirds of those funds were still sitting in money market funds four months later.

“They’re doing a great thing by contributing, and some people do go back to get those dollars invested,” Jaconetti says. “But with money market funds yielding little to nothing, these temporary decisions are turning into ill-advised longer-term investment choices.”

The Vanguard research comes against a backdrop of general improvement in IRA contributions. Fidelity reported on Wednesday that average contributions for tax year 2013 reached $4,150, a 5.7% increase from tax year 2012 and an all-time high. The average balance at Fidelity was up nearly 10% year-over-year to $89,100, a gain that was fueled mainly by strong market returns.

Fidelity says older IRA savers racked up the largest percentage increases in savings last year: investors aged 50 to 59 increased their contributions by 9.8%, for example—numbers that likely reflect savers trying to catch up on nest egg contributions as retirement approaches. But young savers showed strong increases in savings rates, too: 7.7% for savers aged 30-39, and 7.3% for those aged 40-49.

Users of Roth IRAs made larger contributions than owners of traditional IRAs, Fidelity found. Average Roth contributions were higher than for traditional IRAs across most age groups, with the exception of those made by investors older than 60.

But IRA investors of all stripes apparently could stand a bit of tuning up on their contribution habits. Jaconetti suggests that some of the automation that increasingly drives 401(k) plans also can help IRA investors. She suggests that IRA savers set up regular automatic monthly contributions, and establish a default investment that gets at least some level of equity exposure from the start, such as a balanced fund or target date fund.

“It’s understandable that people are deadline-oriented,” Jaconetti says. “But with these behaviors, they could be leaving returns on the table.”

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MONEY 401(k)s

How to Fix the 401(k) and Income Inequality in One Fell Swoop

A top economic adviser wants to cut the tax break for 401(k) savings for high earners and launch a new government plan with a generous match and low fees.

Two hot-button economic issues appear to be colliding: the failed 401(k) plan and growing income inequality. Both have been garnering headlines, and now a noted expert is tying them together through proposed reform.

Gene B. Sperling, a former White House economic adviser in both the Clinton and Obama administrations, wants to cut the tax advantage of 401(k) contributions to top earners. He also wants to create a government-funded universal 401(k) plan that would incorporate all the best parts of these plans—low fees, safety, a generous match, and automatic enrollment.

Presumably, a government-backed 401(k) plan also would offer an option like deferred annuities, which the industry has been resisting, and an easy way to convert some or all of your 401(k) balance to guaranteed lifetime income upon retirement. Both those provisions have had strong backing from the White House.

In a New York Times op-ed, Sperling blamed an “upside-down tax incentive system” for contributing to income inequality in America, adding “it makes higher-income Americans triple winners and people earning less money triple losers” as they save for retirement.

Currently top earners pay a federal tax rate of 39.6%, which makes their tax deduction for 401(k) contributions more valuable than the deduction for contributions of those in lower tax brackets. Top earners also have more tax-advantaged savings opportunities, and they benefit more from employer matches. The upshot, Sperling asserts, is that the top 5% of earners get more tax relief for saving than the bottom 80%. He proposes a flat 28% tax credit for saving, regardless of income.

His universal 401(k) plan also would skew toward lower income households with a dollar-for-dollar match up to $4,000 a year below certain income thresholds. Higher income households would be capped at 60 cents on the dollar—still about double the average match today.

Sperling isn’t the first to champion a universal 401(k) or fret publicly about income inequality. President Clinton floated universal accounts in 1999. Versions of this government-funded plan exist in parts of Europe, and Teresa Ghilarducci, a professor of economics at the New School and author of When I’m Sixty-Four, has been arguing for years for private sector workers to be able to enroll in cost-efficient and professionally managed state-operated retirement programs.

So far the idea hasn’t gotten much traction. The debate in Washington has centered on Social Security and tax reform. Maybe this op-ed from a beltway insider is a sign that 401(k) reform—and income inequality—will heat up as an issue in the coming election cycle.

If so, paying for it all will surely be part of the debate. But not to worry, writes Sperling. Among other possibilities, we could cut the federal estate tax exemption. Currently a married couple can leave $10.7 million to heirs tax-free. Cutting the exemption to $7 million would free up billions to bolster the retirement accounts of lower earners and shore up some of what’s wrong with 401(k) plans today—and take a further whack at income inequality in the process.

Related:

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MONEY 401(k)s

Why Your 401(k) Won’t Offer This Promising Retirement Income Option

More investors are flocking to deferred annuities, which kick in guaranteed income when you're old. But 401(k) plans aren't buying.

Longevity risk—that is, the risk of outliving your retirement savings—is among retirees’ biggest worries these days. The Obama administration is trying to nudge employers to add a special type of annuity to their investment menus that addresses that risk. But here’s the response they’re likely to get: “Meh.”

The U.S. Treasury released rules earlier this month aimed at encouraging 401(k) plans to offer “longevity annuities”—a form of income annuity in which payouts start only after you reach an advanced age, typically 85.

Longevity annuities are a variation of a broader annuity category called deferred income annuities. DIAs let buyers pay an initial premium—or make a series of scheduled payments—and set a date to start receiving income.

Some forms of DIAs have taken off in the retail market, but longevity policies are a hard sell because of the uncertainty of ever seeing payments. And interest in annuities of any sort from 401(k) plan sponsors has been weak.

The Treasury rules aim to change that by addressing one problem with offering a DIA within tax-advantaged plans: namely, the required minimum distribution rules (RMDs). Participants in workplace plans—and individual retirement account owners—must start taking RMDs at age 70 1/2. That directly conflicts with the design of longevity annuities.

The new rules state that so long as a longevity annuity meets certain requirements, it will be deemed a “qualified longevity annuity contract” (QLAC), effectively waiving the RMD requirements, so long as the contract value doesn’t exceed 25% of the buyer’s account balance or $125,000, whichever is less. (The dollar limit will be adjusted for inflation over time.) The rules apply only to annuities that provide fixed payouts—no variable or equity-indexed annuities allowed.

But 401(k) plans just aren’t all that hot to add annuities—of any type. A survey of plans this year by Aon Hewitt, the employee benefits consulting firm, found that just 8% offer annuity options. Among those that don’t, 81% are unlikely to add them this year.

Employers cited worry about the fiduciary responsibility of picking annuity options from the hundreds offered by insurance companies. Another key reason is administrative complication should the plan decide to change record keepers, or if employees change jobs.

“Say your company adds an annuity and you decide to invest in it—but then you shift jobs to an employer without an annuity option,” says Rob Austin, Aon Hewitt’s director of retirement research. “How does the employer deal with that? Do you need to stay in your former employer’s plan until you start drawing on the annuity?”

Employees are showing interest in the topic: A survey this year by the LIMRA Secure Retirement Institute found 80% would like their plans to offer retirement income options. The big trend has been adding financial advice and managed account options, some of which allow workers to shift their portfolios to income-oriented investments at retirement, such as bonds and high-dividend stocks. Some 52% of workplace plans offered managed accounts last year, up from 29% in 2011, Aon Hewitt reports.

“The big difference is the guarantee,” says Austin. “With the annuity, you know for sure what you are going to get paid. With a managed account, the idea is, ‘Let’s plan for you to live to the 80th percentile of mortality, but there’s no guarantee you’ll get there.'”

Outside 401(k)s, the story is different. Some forms of DIAs have seen sharp growth lately as more baby boomers retire. DIA sales hit $2.2 billion in 2013, more than double the $1 billion pace set in 2012, according to LIMRA, an insurance industry research and consulting organization. Sales in the first quarter this year hit $620 billion, 55% ahead of the same period of 2013.

Three-quarters of those sales are inside IRAs, LIMRA says, since taking a distribution to buy an annuity triggers a large, unwanted income tax liability. But the action—so far—has been limited to DIAs that start payment by the time RMDs begin. The new Treasury rules could accelerate growth as retirees roll over funds from 401(k)s to IRAs.

“For some financial advisers, this will be an appealing way to do retirement income planning with a product that lets them go out past age 70 1/2 using qualified dollars,” says Joe Montminy, assistant vice president of the LIMRA Security Retirement Institute. “For wealthier investors, [shifting dollars to an annuity] is also a way to reduce overall RMD exposure.”

Could the trend spill over into workplace plans? Austin doubts it. “I just don’t hear a major thirst from plan sponsors saying this is something we should have in our plan.”

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MONEY Get On The Right Path

Half of Workers Are on Track to Retire Well—Here’s How to Join Them

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Save 15% of pay for 30 years and you will be fine, a new study shows. Save for longer, and it gets much easier.

The shift from traditional pensions to 401(k) plans hasn’t gone well for most workers. One in two U.S. households are destined for a lifestyle downgrade in retirement, data show, as guaranteed lifetime income from old-style pensions disappears. But new research finds that most families can stay on track to a comfortable retirement by regularly saving 15% of pay over 30 years. Start earlier, and you only need to put away 10%.

The news isn’t all bad if you’re starting late. Even folks past age 50 have time to adjust. But clearly those with the shortest windows to retirement have the steepest hill to climb—and probably need to start factoring in a longer working life and more austere retirement lifestyle right away.

The typical middle-income household headed by someone 50-plus, and with a projected retirement shortfall, would need to boost its savings rate by 29 percentage points to retire comfortably at age 65, according to the Center for Retirement Research at Boston College. That would mean saving, say, 39% of every paycheck instead of 10%.

Calling this savings rate “unrealistic,” researchers Alicia H. Munnell, Anthony Webb, and Wenliang Hou conclude in their paper, “A better strategy for these households would be to work longer and cut current and future consumption in order to reduce the required saving rate to a more feasible level.” One thing the paper does not mention is that one in 10 U.S. workers is limited or unable to work due to poor health—and those past age 65 are three times more likely to have this issue, according to the National Health Interview Survey.

On a cheerier note, younger middle-income workers currently on track to fall short of retirement income still have time to realize their dreams by boosting savings just 7 to 13 percentage points (the younger you are, the lower the savings rate needed), research shows. The impact of starting early and letting your savings compound over more years cannot be overstated.

The typical wage earner planning to retire at age 65 in 2040 would need to build a nest egg of $538,000, the paper states. By purchasing an immediate annuity, you would replace 34% of pre-retirement income. Social Security would replace 36% of pre-retirement income—in all giving the household 70% of pre-retirement income, which is considered an acceptable minimum level. To reach this savings goal this household would have to save 15% of every paycheck starting at age 35. But if the household planned to work to age 70—or started saving five years earlier—it would need to save just 6% of every paycheck.

In general, the typical middle-income household must save enough to produce a third of its retirement income. Low-income households need only get a quarter of retirement income from savings. High-income households (with a more expensive lifestyle) need to save enough to produce half their retirement income, the paper found.

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The Amazing Result of Actually Trying to Save Money

 

MONEY Social Security

How to Fix Social Security — and What It Will Mean for Your Taxes

As Baby Boomers retire, the Social Security trust fund is getting closer to running out of money, a new study finds.

Last week I explained why I thought it would be a bad idea to close Social Security’s long-term funding gap by simply making all wages — not just those up to the annual ceiling, which this year is $117,000 — subject to payroll taxes, thereby socking it to wealthier workers. That wasn’t a popular opinion among those who feel it only right to raise the levies on the top 1%, or even top 5%.

“When all other sources have been depleted soak the portfolio holders even more disproportionately,” one critic responded via social-media .

Tweets, unfortunately, don’t make great policy arguments. And as Social Security’s doomsday clock keeps ticking, it’s all the more urgent to come up with a balanced reform strategy and act on it. Last week the Congressional Budget Office projected Social Security’s trust funds would be depleted during calendar year 2030—a year earlier than its previous estimate. If this happens, the program could then pay only about three-fourths of its scheduled benefits.

How, then, to close the funding gap? Although I do not want to see the wealthy as the primary bill-payer for Social Security reform, I do think the payroll tax ceiling is set too low. Today that ceiling, which is $117,000 this year, captures about 83% of all wage income, but it used to apply to 90%. The reason for the decline is widening income inequality, as the upper end of the wage scale has soared disproportionately higher.

Raising the ceiling until it once again covers 90% of the nation’s wage income would help, somewhat, to improve Social Security’s finances, the CBO found. The big headline here is that hiking the ceiling to cover 90% of wages would require a huge jump—from a projected $119,400 in 2015 to $241,600. The steep hike is necessary because high-end earners are a relatively small slice of the U.S. population. Even so, raising the payroll tax ceiling, which more than doubles the amount of Social Security payroll taxes paid by wealthier earners, would close only 30% of the system’s projected 75-year actuarial deficit.

You might wonder why we don’t eliminate the ceiling altogether so all wages are subject to payroll taxes. Glad you asked. Eliminating the ceiling would still close only 45% percent of the deficit, according to CBO. Both these projections assume that wealthier people would also see their Social Security benefits increase.

To make a more significant reduction in the deficit, you could limit Social Security benefit increases for the wealthy to only an additional 5% of pre-retirement earnings. In that scenario, along with eliminating the earnings ceiling, we could close nearly two-thirds of the funding gap. Still, as I wrote last week, I think soaking the rich this way is nearly as bad as soaking poorer people. Soaking people is not what Social Security was or should be about. It’s about requiring people to set aside enough money through a mandatory payroll tax to provide them a modest level of retirement security.

For most people the payouts are, indeed, modest. In 2013 a 66-year old who had earned average wages during his or her working life would qualify for lifetime Social Security payments beginning at $19,500 a year. This amounts to 45% of average pre-retirement income. What’s more, most workers file for benefits early, which sharply reduces the level of income replacement.

Yet that’s pretty much how the program was designed, and even these low levels of replacement income have been enough for Social Security to be a spectacular success. Before the program began in the ‘30s, retirees had the highest poverty rate of any age group. Today they have the lowest. (Medicare gets major credit as well.)

Problem is, even as Social Security has worked well, the other parts of the retirement system have fallen apart. The move from defined benefit pensions to 401(k)s and other defined contribution plans has shifted enormous retirement risk from employers to employees, and the numbers show that many aren’t saving enough to meet their goals.

Given the looming retirement shortfall, there has been growing support to expand Social Security benefits, not contract them. That will be tough to do. As the CBO reported last week, under current rules Social Security’s long-term deficits will continue to balloon. Over the next 25 years, program income will amount to 5.2% of the nation’s gross domestic product, while program benefits will account for 6%.

The fundamental problem is the aging of America. As the wave of Baby Boomers moves into retirement, the number of people collecting Social Security is projected to rise by roughly a third from 58 million today to 77 million in 2024—and by nearly 80% to more than 103 million by 2039. By contrast, the work force, defined as people aged 20 to 64, is expected to increase by only 5% by 2024 and just 11% by 2039.

Something’s got to give. Higher taxes, in one form or another, are inevitable.

Philip Moeller is an expert on retirement, aging, and health. He is an award-winning business journalist and a research fellow at the Sloan Center on Aging & Work at Boston College. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

MONEY Ask the Expert

Help, My Spouse Is Afraid of Stocks. What Should I Do?

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Robert A. Di Ieso, Jr.

Q: I just got married, and my husband and I are both contributing to 401(k)s. But he is very conservative with his investments and keeps very little in stocks. We have more than three decades till retirement. How can we align our 401(k)s so we both feel comfortable?

A: It’s certainly not unusual for a couple to have different attitudes about how to manage their money. Spouses often aren’t on the same page when it comes to personal finances. But when you are investing for retirement, being too conservative can make it harder to reach your long-term goals.

“You need some of the risk that comes with investing in stocks, or you won’t have enough growth to fuel your portfolio for the long run,” says San Diego financial planner Marc Roland. And the younger you are, the more risk you can afford to take with your retirement money.

That’s because you have more time to ride out the anxiety-inducing downturns in the markets. Financial planners recommend using your age and subtracting it from 110 to get the percentage of your portfolio that you should keep in stocks. A 30-year-old, for example, should have roughly 80% of their holdings in equities.

So how do you mesh that guideline with an asset allocation that doesn’t panic your husband when the market drops?

First, understand that asset allocation isn’t the only important factor you should consider. How much you put away has more impact on your retirement savings success than how you invest your money. When you’re decades from retirement, it’s hard to know exactly how much you’ll need for a comfortable lifestyle at 65. But one rule of thumb is that you’ll need 70% of your pre-retirement salary to live comfortably. You can get a good ball park estimate with a calculator like this one from T. Rowe Price.

The more you are contributing to your 401(k)s, the less risk you have to take on, says Roland. If you’re both saving at least 10% of your income, and you boost that rate to 15% or more as you get older and earn more, a balanced portfolio of about 60% in stocks with the rest in bonds would work, says Roland. (That ratio of stocks to bonds is a bit conservative for investors in their 20s, who could reasonably stash as much as 80% in equities.)

To achieve that overall mix, the more aggressive spouse can invest 80% in stocks, while the risk-averse spouse can hold the line at 40%, assuming you are contributing similar amounts to your plans. “That blend will give them an appropriate asset allocation but each portfolio is tailored to each person’s risk tolerance,” says Roland.

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MONEY 401(k)s

Why This Popular Retirement Investment May Leave You Poorer

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slobo—Getty Images

Target-date funds are supposed to be simple all-in-one investments, but there's a lot more going on than meets the eye.

Considering my indecision about how to invest my retirement portfolio (see “Do I Really Need Foreign Stocks in My 401(k)?”) you would think there’s an easy solution staring me in the face: target-date funds, which shift their asset mix from riskier to more conservative investments on a fixed schedule based on a specific retirement date.

These funds often come with attractive, trademarked names like “SmartRetirement” and are marketed as “all-in-one” solutions. But while they certainly make intuitive sense, they are not remotely as simple as they sound.

First introduced about two decades ago, the growth of target-date funds was spurred by the Pension Protection Act of 2006, which blessed them as the default investment option for employees being automatically enrolled by defined contribution plans, such as 401(k)s. And indeed, investing in a target-date fund is certainly better than nothing. But the financial crisis of 2008 raised the first important question about target-date funds when some of them with a 2010 target turned out to be overexposed to equities and lost up to 40% of their value: Are these funds supposed to merely take you up to retirement, or do they take you through it for the next 20 to 30 years?

The answer greatly determines a fund’s “glide path,” or schedule for those allocation shifts. The funds that take you “to” retirement tend to be more conservative, while the “through” funds hold more in stocks well into retirement. Still, even target-date funds bearing the same date and following the same “to” or “through” strategy may have a very different asset allocations. For a solution that’s supposed to be easy, that’s an awful lot of fine print for the average investor to read, much less understand.

Then there is the question of timing for those shifts in asset allocation. Some target-date funds opt for a slow and gradual reduction of stocks (and increase in bonds), which can reduce risk but also reduce returns, since you receive less growth from equities. Others may sharply reduce the stock allocation just a few years before the target date—the longer run in equities gives investors a shot at better returns, but it’s also riskier. Which is right for you depends on how much risk you can tolerate and whether you’d be willing to postpone retirement based on market conditions, as many were forced to do after 2008.

In short, no one particular portfolio is going to meet everyone’s needs, so there’s a lot more to consider about target-date funds than first meets the eye. If I were to go for a target-date fund, I would probably pick one that doesn’t follow a set glide path but is instead “tactically managed” by a portfolio manager in the same manner as a traditional mutual fund. A recent Morningstar report found that “contrary to the academic and industry research that suggests it’s difficult to consistently execute tactical management well, target-date series with that flexibility have generally outperformed those not making market-timing calls.”

Maybe it’s the control freak in me, but I prefer selecting my own assortment of funds instead of using a target-date option where the choices are made for you. Granted, managing my own retirement portfolio was a lot simpler when I was young and had a seemingly limitless appetite for risk. But even as I get older and diversification becomes more important, I still want to be in the driver’s seat. Anyone can pick a target, but there is no one, single, easy way to get there.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management.

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MONEY Savings

Millennials Are Hoarding Cash Because They’re Smarter Than Their Parents

Cash under mattress
Zachary Scott—Getty Images

Sure, young adults could get higher returns by investing in stocks, but many have good reasons to stay safe in cash right now.

Another day another study about the short-comings of Millennials as investors. This time around, Bankrate.com weighs in—data from their latest Financial Security Index show that 39% of 18-29 year-olds choose cash as their preferred way to invest money they won’t touch for least 10 years. That’s three times the percentage that would choose stocks.

“These findings are troubling because Millennials need the returns of stocks to meet their retirement goals,” says Bankrate.com chief financial analyst Greg McBride. “They need to rethink the level of risk they need to take.”

Bankrate.com is not the only group trying to push Millennials out of cash and into stocks. Previous surveys have scolded young adults for “stashing cash under the mattress,” being as “financially conservative as the generation born during the Great Depression,” and more being “less trustful of others”—in particular financial institutions and Wall Street. (You can find these surveys here, here and here.)

These criticisms are way overblown. It’s simply not true that Millennials are uniquely averse to equities—many are investing in stocks, despite their responses to polls. As for cash holdings, keeping a portion of your portfolio liquid is simply common sense, though you can overdo it.

Here’s what’s really going on:

  1. Millennials are not much more risk averse than older generations. In the wake of the financial crisis, investors of all ages have been keeping more of their portfolios in cash—some 40% of assets on average, according to State Street’s research. Baby Boomers held the highest cash levels (43%), followed by Millennials (40%) and Gen X-ers (38%). That’s not a wide spread.
  2. Many Millennials do keep significant stakes in equities. This is especially true of those who hold jobs and have access to 401(k) plans. That’s because they save some 10% of pay on average in their 401(k)s, which is typically funneled into a target-date retirement fund. For someone in their 20s, the average target-date fund invests the bulk of its assets in stocks. Thanks to their early head start in investing, these young adults are an “emerging generation of super savers,” according to Catherine Collinson, president of the Transamerica Center for Retirement Studies.
  3. Young adults who lack jobs or 401(k)s need to keep more in cash. Most young people don’t have much in the way of financial cushion. The latest Survey of Consumer Finances found that the average household headed by someone age 35 or younger held only $5,500 in financial assets. That’s less than two months pay for someone earning $40,000 annually, barely enough for a rainy day fund, let alone a long-term investing portfolio. Besides, that cash may be earmarked for other short-term needs, such as student loan repayments (a top priority for many), rent, or more education to qualify for a better-paying job.

There’s no question that young adults will eventually have to funnel more money into stocks to meet their long-term right goals, so in that sense the surveys are right. But many are doing better than their parents did at their age—the typical Millennial starts saving at age 22 vs 35 for boomers. And if many young adults hold more in cash right now because they’re unsure about their job security or ability to pay the bills, there are worse moves to make. After all, it was overconfidence in the markets that led older generations into the financial crisis in the first place.

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