The time-worn saying, "It's OK to buy green bananas," is becoming a financial planning mantra for baby boomers facing the changing realities of retirement.
Presumably, a person who buys green bananas is expecting to be around long enough to see the bananas ripen. For baby boomers -- the generation born between 1946 and 1964 -- increased longevity is far and away the most significant new retirement reality.
Increased Life Expectancy: Retirement Planning Wild Card
In our grandparent's generation, life expectancy was in the 70s. Now, for a married couple age 65, there is a 50 percent chance that one of them will live past their 90th birthday. This stretches the time horizon for boomers who are thinking about when to retire.
Think back 25 years ago, to 1987. Our grandparents who retired then at 65 only had to be prepared for a retirement lasting five to 10 years. Today, a 65-year-old who wants to retire now needs financial resources that will last 25 to 30 years. For investment advisors, that meansdeveloping a retirement financial plan out as far as 2040 and beyond.
Heredity often plays a role in longevity. If a person comes from a family in which people frequently have lived into their 80s and 90s, he or she may live as long or longer. Baby boomers need to imagine retiring at 65 and living to age 95 or 100. That means they would need 40 to 45 years of steady retirement income.
With increasing longevity, baby boomers not only need to save for retirement but also be prepared to save in retirement for the decades ahead. This will involve more than budgeting. In order to save in retirement, boomers will need to invest with growth and tax efficiency in mind-year after year.
Looking ahead to retirement, baby boomers may not realize that their cash flow could be more important than savings when it comes to providing retirement income. While the number one retirement fear is someday running out of money, the client's income stream may actually prove more important than his or her retirement nest egg.
Creating A Vision For Retirement
When we sit down at the table with 48- to 66-year-olds looking for retirement planning advice, the first thing we ask is, "How much are you going to need in today's dollars to retire?" We want them to create a vision for their retirement. Do they need $5,000, $10,000 or $20,000 per month, after taxes? Then we look at their assets, which could include a 401k plan, IRAs, real estate and other taxable investments. We make an assumption of what the returns will be. Finally, we project the inflation rate. This process helps us determine if clients, given their retirement vision, have enough money to retire comfortably. It also helps us determine where the client should be putting their money in today's market to meet any shortfall.
Whether through disciplined saving, shrewd investing or timely inheritance -- or a combination of these factors -- a growing segment of the middle class today has $1,000,000 or more in investable assets. Most of the "middle class millionaires" we deal with are making $150,000 to $300,000 a year. They are aiming to have a balance during their retirement years that enables them to continue to enjoy a multifaceted life.
Key Retirement Planning Considerations For Boomers
Retirement financial planning considerations vary from person to person. These include the health of the client, desired activities of the client in retirement and whether or not the client has children or grandchildren and intends to support them. For example, a single male with no children has far different retirement planning priorities than a couple planning to send their grandchildren to college.
One of the fundamentals of successful retirement planning is having the mindset to be a saver. We see teachers with modest annual incomes, but who have been prudent savers over the years, amass huge retirement nest eggs. At the same time, we see doctors making a million dollars a year who haven't even saved $10,000. Parents who teach their children to be disciplined savers, and set the proper example by saving regularly themselves, are planting seeds of financial responsibility that will be reaped when their kids are approaching retirement age. It is amazing how quickly the money adds up.
Maintaining Purchasing Power
With the federal government currently spending 50 percent more money than it brings in, the biggest challenge for retiring baby boomers is going to be maintaining purchasing power in the face of potential increasing inflation.
The comparative numbers are eye-opening. In 1990, for example, $500,000 invested in 10-year Treasury notes generated $$40,000 in annual interest income. But the current yield on 10-year Treasuries is only 1.5 percent. As a result, in 2012 the same $500,000 invested in 10-year Treasuries is producing only $7,500 in interest income. Meanwhile, prices are going up for gas and groceries at an inflation rate of around 2.5 percent. To maintain the same standard of living, the retiree would have to start eating into the $500,000 principal. Again, with longer life expectancies produced by healthcare advances and generally healthier lifestyles, boomers may to have to make their retirement "nest eggs" last for 25 years or more.
Segmented Investment Strategy
Investment advisors need to break things down into short-, intermediate- and long-term segments for their clients. In the short term, one to three years out, retirees need highly secure investments with a predictable return on principal. They don't want to be trading stocks to come up with the money for next month's nursing home bill. Short term investment products that are highly secure with a predictable return include money market funds, CDs, U.S. Treasury bills and other U.S. government notes and bonds.
The intermediate investment term is four to 10 years. In this segment, we are looking for higher yield and we can find it in high-quality corporate bonds backed by companies such as IBM, Procter & Gamble and AT&T. Currently, investors can obtain a dividend yield from more than 300 of the S&P 500 companies that is higher than the 10-year Treasury yield of 1.5 percent.
Another intermediate investment option is a real estate investment trust (REIT). REITs, such as the Washington Real Estate Investment Trust, own office buildings, apartments and shopping centers. REIT securities are currently paying a 4.5 percent yield, three percent higher than U.S. Treasuries.
Ten years and beyond, the key issue is to maintain long-term purchasing power. Investment products that are appropriate in this segment are common stock, mutual funds and exchange-traded funds (ETFs). ETFs are investment funds traded on stock exchanges, much like stock.
Three Mistakes To Avoid In Boomer Retirement Planning
In my 29 years in the business, I have seen three fundamental mistakes that people make in planning for retirement. With today's new retirement realities, it is more important than ever before for baby boomers to avoid making these mistakes.
The first mistake is not taking full advantage of the employer sponsored retirement plan. Under current 401k rules, individuals over age 50 can contribute $22,500 per year to their plan. But today's average 401k value is just over $60,000. If most people were doing the match - making the maximum annual contribution - that number would be far, far higher.
The second most common mistake people are making in retirement planning is failing to diversify their investment strategy from a concentrated stock position. A baby boomer's fortune should not be based on one company, but many employees take only the company stock option. Fannie Mae employees, for example, who fell into this trap now find that their stock portfolio is worth nothing. There is no reason why your clients can't diversify their risk when it comes to the stock market.
A third mistake is not investing in international markets. Brazil, Russia, India and China - the BRIC countries - now produce 18 percent of world's gross domestic product (GDP). The U.S. economy, which currently produces 48 percent of the world's GDP, is lucky to grow at two percent per year. Meanwhile, growth of Europe's GDP is flat. But the GDP of the BRICs is projected to grow at eight percent per year, and by 2030 these four countries are projected to generate 30 percent of world's GDP.
If and when the United States is eventually forced to devalue its currency; it will be the BRICs and other countries with strong GDPs that will be the survivors. Thus, investing in countries with stronger long-term fundamentals can be one of the keys to maintaining long-term purchasing power during retirement. Fortunately, it is easy to buy into the BRICs through international mutual funds and ETFs.
When all is said and done, baby boomers nearing retirement age need to stay focused on the long term horizon. Statistically, there is a good chance they will live until their 90s. That means they will have the opportunity to watch plenty of green bananas ripen - if they have the money to buy them.
Clark Kendall, founder of Kendall Capital Management in Rockville, Md., has more than 20 years of experience in investment management and wealth management strategies. He is one of a select few professionals in the world who has earned the triple designations of Chartered Financial Analyst, Chartered Financial Planner and Accredited Estate Planner. Kendall focuses on providing independent financial direction to middle-class millionaires in and around Montgomery County, Md.