Amid the market melee, you may be starting to question the investment strategy behind your battered portfolio, but before you attempt any knee-jerk moves to mitigate risk, consider the impact an uber conservative investment stance might have on your ability to feather your nest egg.
Indeed, for most Americans the threat of outliving their retirement savings far outweighs any short-term investment risk the bear markets dishes out.
An Ernst & Young study in July concluded that nearly three out of five recent middle-class retirees will outlive their assets if they attempt to maintain their pre-retirement standard of living.
It also found that those seven years away from retirement will have to reduce their standard of living by 37 percent to make their money last.
"I don’t think we’ve really seen the wave of those whose savings are too short even occur yet," says Joseph Birkofer, a certified financial planner and principal with Legacy Asset Management in Houston, Texas.
A variety of factors are driving the savings shortfall, says Dallas Salisbury, president and chief executive of the Employee Benefit Research Institute.
For starters, Americans are living longer than before, meaning those who retire in their early 60s (the traditional age of retirement) could spend 30 years or more living off their savings—a daunting financial proposition for most.
Meanwhile, health care costs continue to climb, while federal health insurance coverage declines. "When Medicare was in its early years, it paid about 80 percent of a retiree’s medical expenses," says Salisbury. "Now, it pays about 50 percent."
Lastly, of course, is the overwhelming lack of financial discipline.
In the absence of guaranteed income (once provided by pension plans), too few savers have had the willpower or foresight to fund their own retirement using 401(k)s or IRAs.
So, here's a few tips.
How Much Is Enough?
First and foremost, says Birkofer, determine how much money you’ll need to cover retirement.
Start by adding up basic living expenses, such as groceries, gas, mortgage (unless it will be paid off by retirement), utilities, taxes and health and auto insurance premiums.
Next, add up discretionary expenses. (Think cable TV, cell phones, entertainment.)
Finally, add up any guaranteed sources of income you’ll have, including Social Security, pensions, and rental income from real estate.
The difference between expenses and income is the amount you’ll need to finance with personal savings.
"For someone approaching retirement, visibility of their expenses is the single greatest source of stress relief that I have found—more so than portfolio allocations," says Birkofer.
Another way to reduce stress is to create income streams.
"The smartest thing an individual can do is buy an inflation indexed annuity that covers your basic living expenses," he says. "That way, if I put all my leftover money in the market and it goes down significantly, it doesn’t create a crisis."
Make sure your annuity income is enough to cover long-term care insurance premiums. Such coverage helps pay for costly medical care for chronic illnesses, including assisted living.
"One of the biggest mistakes many retirees make is that they buy life insurance, they pay the premiums for 20 years and then when they’re 80, when they need their insurance most, they run out of money and can no longer afford the premiums," says Salisbury. "If you have to choose between long-term care insurance and food, you choose food."
Cash Is King
Another way to avoid depleting your nest egg is to maintain cash reserves.
"You should have enough cash on hand to support your lifestyle for two years on your last day of work," says Birkofer, noting it’s possible to get by with less.
That includes savings in readily convertible assets such as certificates of deposit (CDs), short-term bonds and cash.
"That way, if you have the misfortune of retiring on the day the Dow [Jones Industrial Average] loses 700 points you don’t have to flush out your 401(k)," says Birkofer.
Above all, don’t make the mistake of relying on the outdated rule of thumb, which suggests you’ll only need 70 percent of your pre-retirement income for every year you spend in retirement.
That’s a recipe for disaster, says Birkofer.
"That might have been true when Dad worked, Mom took care of the house and dad retired and hung around the house," he says. "But what we have now is a generation of dual income households and they’re going to have fun and spend money for the first 10 years of retirement."
Your expenses will decrease over the next few years as you stick closer to home and scale back your spending, but higher medical expenses later in life more than make up for it.
Once retired, the single biggest factor in making your nest egg last is the amount of money you withdraw from your portfolio every year.
"People believe they can spend far more of their assets than they can actually afford," says Salisbury.
For a 90 percent chance of outliving your savings, he says, keep your withdrawals to no more than 3 or 4 percent a year.
The idea, of course, is to leave your principal largely untouched, spending only the interest earned, plus a little extra to account for inflation.
Invest For Growth
Resist the urge, too, to overweight your portfolio with low-risk bonds during retirement; if your investments fail to keep up with inflation you're losing purchasing power.
Most investors require a significantly better average annual return than fixed income securities provide, given rising life expectancy rates.
Birkofer says retirees should maintain an asset allocation of 70 percent equities and 30 percent high-quality bonds. "The probability of running out of money goes up with every extra dollar you have in fixed income," he says, adding he favors dividend-paying stocks for their stable income.
Getting By On Less
If you’re already a day late and a dollar short, you can always reduce living expenses— sell your second car, move to a cheaper house or cook more meals at home.
And then, of course, there’s the last line of defense—employment.
If you had planned to retire in the next few years, but now suspect you won’t have enough to live on, postpone your retirement.
"Every additional year of work has a huge savings effect because you’re waiting that much longer to start spending your retirement money, plus you’re adding to your fund with whatever additional money you’re able to save," says Salisbury.
If you’ve already bid farewell to your boss, part-time jobs abound and some provide health care benefits, which means you’ll have extra income and lower expenses.
"That’s the sensible thing to do and it’ll also serve to increase your Social Security benefits—even if you already started collecting," says Salisbury.