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.