Along with the early arrival of "Black Friday" circulars, the winding down of 2010 means it is once again time to rethink and revise retirement planning for the year ahead.
There is, of course, no crystal ball to consult when predicting the year ahead, but there are notable risks to be aware of.
Hard-to-Pin-Down Returns
Bulls and bears alike can ill-afford being too devoted to their particular outlook as calendars flip to 2011.
In recent years, one could traditionally assume an annualized rate of return of about 7% from the stock market. But, as the fine print says, past performance doesn't indicate future returns.
Some economists are predicting future stock returns could be as low as 4% in the coming months; others see a bounce-back that could exceed expectations.
An increased tax on dividends, if one were to gain traction given a Republican-controlled House of Representatives, could further rein in real returns. On the other hand, 2011 could be the year we finally shake off the Great Recession and its stultifying impact on volatile markets.
If the "experts" can't agree on what the future holds, what chance do you have for guesstimating your investments' potential? Unsavory as it may be, the best strategy may be to lowball your expectations. Base your assumptions on a lower-than-average return — 4% to 5%, perhaps — and adjust your portfolio accordingly.
Don't give into the temptation to chase returns if doing so carries the risk or failure. If the worst-case scenario holds true, at least you will have no shock to the system. If returns see an uptick, the pleasant surprise will put you ahead of the game.
The Return of Inflation
The hue and cry over potentially rising tax rates can mask an even bigger threat — inflation. Even a minimal uptick in inflation can have a corrosive impact on your real rate of return and retirement savings. The average (until recently) annual increase of 3% could pluck thousands of dollars from your savings, and the compounded effect could require an eventual lifestyle downgrade once you retire.
Recent moves by the Federal Reserve all but assure a creeping increase that is unlikely to be undone by Washington's halfhearted efforts to trim the nation's debt and deficit. Jumping into tax-advantaged instruments such as municipal bonds may seem a smart way to avoid higher taxes, but there is the very real risk that the upside could be negated by higher inflation.
"Cookie-cutter advice, though once relevant, may not be in everyone's best interest."
For those nearing, or in, retirement, the assumption has to be that investment returns are unlikely to fully offset any inflationary increase. Those lucky enough to still have a traditional pension plan may be dismayed to learn that many are not indexed to inflation. The only positive is that Social Security benefits will probably see their first COLA increase in two years.
As the new year approaches and inflation's return becomes likely, there are some investment alternatives that can help take the edge off — although some have their own set of risks. Treasury inflation-protected securities and inflation-indexed annuities are worth exploring, as are the benefits that may come from commodity plays, so long as you remain diversified and don't go all-in with too heavy a play on gold or other currently booming investments.
Low Interest Rates
Historically low interest rates have been taking a toll on many fixed-income investments. Though Fed policy may reverse this trend next year, anyone approaching retirement should carefully evaluate their exposure to these investments.
Though a move to long-term bonds may seem the way to go, be aware that the current state of the bond market may negate this traditional advantage. Going against the grain, numerous fund managers say they see greater value in putting their money to work in short-term or intermediate-term bonds.
As a counterstrike, dividend-paying stocks could likely make more sense to your bottom line. Popular and profitable companies paying a dividend include:
Wal-Mart ,
Bristol-Myers Squibb ,
McDonald's ,
Procter & Gamble ,
Coca-Cola ,
Johnson & Johnson ,
Pfizer ,
Verizon and
AT&T .
A Moving Target
The old rule of thumb was that investment risk should be dialed back the older you get. Young investors, with a longer time horizon before retirement, have been taught to jump wholeheartedly into the equity market to maximize their returns.
Conversely, the closer you get to retirement, a retreat from the stock market to the relative safety of cash, bonds and other fixed-income plays is not only standard advice but the supposed model upon which Target Date Funds are based.
Unfortunately, this cookie-cutter advice, though once relevant, may not be in everyone's best interest. Diminished returns have created the need to replenish what was lost and pre- and post-retirement expenses — notably health care and long-term care — are ballooning.
Not including nursing home care (which can cost upward of $70,000 a year or more), various studies have pegged the out-of-pocket health care costs for retirees at about $250,000. The average rate of medical inflation during the past two decades has been nearly 6%, a number likely to increase for at least the next few years even with federal health care reforms.
As investors rebalance their portfolios entering 2011, increasing expenses, diminished returns and uncertainty about inflation will require that they either adjust their risk profile or downgrade retirement expectations to avoid outliving their assets.
A recent study by Aon Consulting, the global human capital consulting organization of Aon, detailed the percentage of one's final annual salary to keep the same standard of living after retirement.
It concluded that a worker earning $50,000 at retirement will need to replace 81% of that amount annually to continue the same standard of living. A worker earning $150,000 at retirement will need to replace 84% of that salary to continue the same preretirement standard of living. Social Security will provide only 23% ($34,500), while the employer retirement plan and/or worker's own savings must account for the remaining 61% ($91,500) each year.
Backlash Against Advice
The psychic toll of the recession still lingers for many, and distrust of financial professionals could hamper their success going forward, says the American Society of Actuaries.
An SOA report last month notes a number of factors contributing to the possibility of an "impending retirement savings crisis," including sustained rises in health care costs, increased life expectancy, and the possibility of future reductions in government-provided retirement benefits. These factors, along with the growth and increasing complexity of financial products and services, call for more financial education for consumers, it says.
Among the conclusions:
- Many non-affluent consumers lack the basic financial knowledge necessary to seek and use financial advice. Recent turmoil in the financial markets has significantly lowered consumer confidence and trust in the financial services profession.
- The non-affluent especially shy away from financial advisers who sell products, suspecting an inherent conflict of interest. Many non-affluent consumers also seek financial advice only from informal sources, such as family and friends, because they view these sources as inherently trustworthy.
- The financial-advice industry incentivizes its professionals to sell products more than educate consumers.
- There is often a cultural disconnect between financial advisers, who are used to serving wealthy clients, and non-affluent consumers from different cultural backgrounds. Most financial advising firms focus on affluent consumers, since the non-affluent tend to be considered less profitable and require a long-term, high-involvement investment of resources to cultivate business with them.
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TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.