- Investors planning for retirement should assume their investing time horizon is at least their entire life expectancy less their current age.
- Keep in mind, median life expectancies are the "median"—half will live longer.
- Inflation can seriously erode purchasing power over time, particularly if your portfolio isn't allocated properly.
Pretend you're 60 years old and plan on retiring at 65. You've saved up a tidy sum—but you want to avoid major errors. Time to buckle down and get conservative to make sure you don't hit any major market bumps between now and retirement day. Right?
Wrong. Way wrong. Super wrong. Far too many investors make the mistake of assuming a way-too-short investing time horizon. Your investing time horizon isn't your retirement date or some other milestone (e.g., when you start needing portfolio income). Your time horizon is how long the assets need to last. For most of you that means your entire life. And unless you hate your spouse, you should consider his or her life expectancy too.
But even investors who know their life expectancy is their time horizon frequently short-change themselves, as this article points out:
In the Long Term, Assume You Will Still Be Spending
By Ian McDonald, The Wall Street Journal*
Median life expectancy is getting longer due to medical advancements. And if you have longevity in your genes, that extends your timeframe too. But here's the important part—the median life expectancy is just that—the median. Half can and should expect to live longer—maybe to age 100! Failing to do so might mean running short on funds later in retirement—never fun. And keep in mind, many retirees find they need more money in retirement, not less. There are increasing health care costs, sure, but what about golf (not cheap), travel (also not cheap), and grandchildren (really really expensive).
We heartily agree with this article's assessment that "longevity is probably the single most important issue faced by any investor—period." But a later recommendation that retirees sock their assets away in an immediate annuity is frightfully, frightfully wrong. In fact—it flies in the very face of the rest of the article!
An immediate annuity is an insurance product (not investment product) in which the buyer relinquishes ownership of his (or her) hard-earned assets in return for a guaranteed income stream. Sounds great, right? Guaranteed! Guarantees are fun. Nothing's ever guaranteed with investing! But buying an immediate annuity pretty much guarantees inflation will kill you.
We all know you should assume a longer time horizon (and it can't hurt to err on the side of longer vs. shorter). So let's say you have a 30-year time horizon (or longer!). If you need $50,000 a year to maintain your lifestyle—in 30 years you'll likely need $125,000 because of inflation! Said another way: If you buy an immediate annuity, start thinking about how to explain to your spouse that in 30 years, you'll be living on 60% less. And, you surrender ownership of the assets. If you get hit by a bus the day after buying the annuity—too bad, so sad—the insurance company gets your money, not your spouse or kids.
Investors like annuities and even big allocations of fixed income in retirement because they think they have to get conservative. Wrong way to think. That money needs to work for 20, 25, 30 years or more—that's a long time! Many investors fear short-term stock volatility because they don't think long-term enough (and they forget bond prices are volatile too!). Once you get in your bones you have a much longer time horizon, stocks stop looking so scary. You know what looks terrifying? Your spouse's face when you say, "You know how we live on $50,000 a year? How does $20,000 a year grab you?"
Forget annuities—what about bonds? If you have a long time horizon, stocks, or at least a hefty allocation of stocks, are probably most appropriate for you. Since 1926 there have been 62 rolling 20-year periods. In all but one (98% of the time), stocks beat bonds handily—and by an average margin of 3.8 to 1 margin. Some Gloomy Gus might say, "Yeah, but there was that one period. I'll take the inferior returns in exchange for less day-to-day volatility." Be our guest, but the margin for that one 20-year period when bonds beat stocks was a less impressive 1.4 to 1. Big whoop. In our view, hardly worth the odds. Plus, that one period required buying at the peak in 1929 and riding down the Great Depression into World War II—a pretty unique period.
Assuming a longer time horizon is the first step, but you can still get slaughtered if you don't craft your strategy with enough growth. If you don't relish living on much less later in retirement, bonds can actually be far riskier than stocks. As for the immediate annuity—we'll assume you don't hate your spouse enough to make that mistake.