3 biggest risks every retirement saver should know about

People always talk about “risk” in investing articles, but rarely explain what they mean by it. What sorts of risks should I be concerned about when investing and planning for retirement and what can I do about them? — Ernie G., Newark, Ohio


You’re right. People often toss around the word “risk” as if there’s only one risk we face. In reality, there are a variety of risks that you should be taking into account when it comes to investing and planning for retirement.

Here’s a rundown on what I consider the three biggest, plus advice on how to manage each one.

1. Investment risk.

Traditionally, investors have equated risk with the extent to which an investment’s price or returns bounce up and down. The greater the volatility, the riskier the investment. And to quantify that volatility in a mutual fund, ETF or portfolio of investments, investors typically turn to standard deviation, a measure that calculates how much an investment’s annual return fluctuates around its long-term average annual return.

The bigger the standard deviation, the more volatile the investment. You can find the standard deviation for any fund or ETF by clicking on the Ratings & Risk tab on its Morningstar page.

But many individual investors have trouble relating to this technical measure. Besides, while it’s easy to find the standard deviation for a single fund or ETF – for reasons too technical and boring to go into here – it’s harder to calculate it for your entire portfolio.

I think a more accessible gauge for most people is how an investment or group of investments fares during a big market downturn. In the financial crisis year of 2008, for example, U.S. stocks lost 37%, international stocks slumped 46% and U.S. bonds gained 5%. If you’re considering a portfolio of, say, 50% U.S. stocks, 20% foreign and 30% bonds, you can fairly easily calculate that such a portfolio would have lost about 26% in 2008 financial.

There’s no guarantee you’d see the same results in the next crash, but you’ll have a decent idea of how different assets have fared and how they, and your overall portfolio, might do in future downturns. If you think you might panic facing such a loss, then you probably want to scale back your stocks holdings to a level where the loss would be tolerable.

2. Shortfall risk.

This risk measures the probability that you’ll fall short of a goal, such as being able to maintain your current standard of living during retirement. You can assess this risk by going to a retirement income calculator that employs Monte Carlo simulations, or hundreds of different scenarios to estimate how often you end up with the result you want.

After plugging into the calculator such information as your age, how much you already have saved, how your savings are invested, how much you expect to save between now and retirement and when you plan to retire, the calculator will estimate the probability that you’ll be able to sustain a given level of income in retirement.

If you find you have only a 60% chance that your savings plus Social Security will generate the retirement income you’ll need, you’ll probably want to save more, retire later or make other adjustments to improve your chances of achieving a secure retirement.

I like this gauge of risk because it looks at the big picture. If you’re a nervous Nellie investor and you consider just investment risk, you might decide to huddle in a portfolio of mostly cash and bonds. But the returns from such a conservative investing strategy might be too low to build a nest egg large enough to sustain you in retirement.

By looking at shortfall risk, you’ll be able to tell whether you need to make adjustments to your saving, investing strategy and anticipated retirement date.

3. Emotional risk.

Even when we know intellectually the investing risk or shortfall risk we face, we sometimes make emotional or impulsive decisions and, in effect, become our own worst enemy.

Many people, for example, invest more aggressively and take on more risk after the market’s been on a big run. Is that because their ability to withstand a setback has changed and they can now tolerate a bigger loss? No, it’s because the giddiness of a bull market lulls them into a false sense of security, leading them to underestimate the risk they’re actually taking.

It’s only after the bull market comes to a crashing end and they’re sitting on an unacceptable loss that they realize they let their emotions get ahead of them. This process works in reverse as well. We become overly pessimistic after a market downturn, and invest far too cautiously.

This is a tough risk to manage. All the signals we get from other investors and the financial press during bull and bear markets reinforce feelings of irrational exuberance or undue pessimism. So it’s easy to go along with the crowd and invest too aggressively during good times and too conservatively in bad time.

There are other potential risks to be sure. One example: inflation, which has been relatively tame the past 20 years, could awake from its slumber. But if you focus on the Big Three risks I’ve outlined above and get a handle on them, you’ll have gone a long way toward increasing your chances of having a secure and comfortable retirement.


To Your Successful Retirement!

Michael Ginsberg, JD, CFP® 


How to Prepare for a Mini-Retirement – Instead of saving up for old age, plan to take a career break sooner.


It’s easier to save up for a one-year sabbatical than 30 years of retirement.

US News and World Report, By Joe Udo Oct. 9, 2014 | 10:31 a.m. EDT

Saving for retirement is very difficult when you’re young because retirement is so far off. I certainly didn’t want to save for retirement when I was 21 years old. Retirement was 40 to 50 years away at that point and the timeline was too long to contemplate. However, my dad convinced me to start contributing to my 401(k) and I’m still very thankful for that. I’m 40 now and 65 will be here before I know it. One alternative way to look at retirement saving is to plan for mini-retirements instead. This will break up the timeline so retirement isn’t so far away.

In the past, many workers stuck with one job at a single company for their entire working life. Then they retired with a pension and enjoyed their golden years in comfort. However, this is no longer the case. Companies need to optimize their revenue and layoffs is one of the easiest ways to achieve this. Also, companies often merge or go out of business and employees can’t count on a long career anymore. One result is that employees are less loyal and switch jobs every few years.

Career instability often makes life more difficult but there is an opportunity to look at it from a different angle. Why not plan to take a break from work and recharge your batteries? Workers are increasingly stressed and dissatisfied with their jobs and an extended break can do some good. A year or two off can rekindle the passion you once had for your career or give you the time to find a different career altogether. In the traditional retirement model, workers have many decades to save, but most of us put off this important action. If you plan to take a long sabbatical every 10 to 15 years, then you’ll have to start saving seriously right away.

Here is what you need to do to prepare for a mini-retirement.

1. Save a big percentage of your income. Financial advisors typically recommend saving 10 to 15 percent of your income for retirement. This won’t be enough if you want to retire several times throughout your working life. You will need to increase your savings rate to 30 to 50 percent of your income to have a shot.

2. Reduce expenses and keep lifestyle inflation under control. We tend to spend more when our income increases. But almost everyone can reduce their expenses if they take a good look at what they spend on. Cutting back on non-essential and keeping lifestyle inflation under control can be difficult. You just have to keep the bigger goal in mind and prioritize your spending accordingly.

3. Find alternative ways to generate income. An alternative source of income will greatly help you through those lean years during the breaks. There are many ways to generate income other than a full-time job. For example, you can invest in dividend stocks, buy a rental property, house sit, work odd jobs or start a part-time online business. The income from alternative sources might not be as high as your full-time job, but you won’t be working 60 hours per week either.

4. Track your expenses and budget for travel, retraining and health care. Of course, you don’t want to just hang out at home during your mini-retirements. Many people take this time to travel and see the world at their leisure. You need to track your expenses so you can figure out how much you need to fund a year without a full-time job. Also, depending on your career, you might need to retrain when you’re ready to go back to work. Health care is another big concern, and you need to check how much it will cost to buy private health insurance. All these items are expensive and you’ll need to budget for them.

5. Have an open mind. Taking a year or two off from work can change your life. You’ll have time to pursue your interests and who knows what doors will open. You have to be flexible and look for opportunities when you’re not working full-time.

Taking periodic mini-retirements isn’t for everyone. If your identity is tied to your job, then the traditional retirement model might be a better fit. Financially, you probably won’t be able to build up as much wealth if you take mini-retirements throughout your working years. However, there are many benefits, too. You won’t be burned out from working at the same job for 30 years. You will be able to do whatever you want during those breaks. How many people can live life on their own terms while they’re young? Retirement saving will also be much more urgent because you’ll need to fund those years away from a full-time job.

To Your Successful Retirement!

Michael Ginsberg, JD, CFP® 


Capital from Self-Directed IRAs Flows to Real Estate

Wealth Mangement.com Oct 8, 2014Beth Mattson-Teig

Individuals with self-directed IRAs are adding to the abundant capital flowing into commercial real estate investments these days.

Self-directed IRAs account for just 3 to 5 percent of the broader $6.5 trillion IRA market. Yet even that small fraction amounts to big dollars at an estimated $195 billion to $325 billion, according to data from the Retirement Industry Trust Association (RITA) and the Investment Company Institute. And interest in self-directed retirement accounts is poised to rise further as more individuals look to gain greater control over their investment planning and diversify their portfolios beyond stocks, bonds and mutual funds.

“As workers stay longer in jobs with 401ks and accumulate assets in their 401ks, they are more likely to roll those assets over into a self-directed IRA at some point,” notes Mary L. Mohr, executive director of RITA. “I think that is really creating this huge pool of capital.”

One of the factors fueling interest in self-directed IRAs is that individuals are exhibiting a greater appetite for alternative assets such as real estate, precious metals, commodities, limited liability corporations and hedge funds. “Diversification is a big driving factor in why people want the different types of asset classes non-correlated to the stock market, and they can do that with a self-directed IRAs,” says Mohr.

“Alternative investing is really exploding,” agrees T. Scott McCartan, CEO of Millennium Trust Company in Oakbrook, Ill. Millennium Trust is one of the largest custodians of self-directed IRAs specializing in alternative asset custody and one of the largest providers of automatic rollover solutions. The company has seen explosive growth in the volume of self-directed IRA assets it administers, as well as in custody of private funds, growing from about $733 million in 2005 to just over $11 billion currently. As it relates to alternative asset investing, real estate is often a favored asset for many individuals. People have a desire to invest in things they know and understand, such as a four-plex residential properties or retail buildings that they can drive by every day, says Mohr. And people want to use money in their IRAs to buy those properties. “We see that real estate is the number one choice in terms of the types of assets that self-directed investors want to own,” she says.

Direct investment

The growing self-directed IRA market is an attractive target for real estate funds and sponsors searching for investment capital. “People are going to go where the money is,” says McCartan. For example, individuals with self-directed IRAs are firmly on the radar for real estate crowdfunding groups such as Fundrise and CrowdStreet.

Although individuals have the opportunity to use traditional IRAs and 401ks to invest in real estate via REIT stocks and real estate mutual funds, there is a greater desire to have access to direct real estate investment opportunities. “This is part of a bigger trend that we are seeing moving away from reliance on the stock market as your sole source of access to investments towards more of a decentralized approach,” says Darren Powderly, CCIM, co-founder of Portland-based CrowdStreet.

CrowdStreet’s typical investors are baby boomers with IRAs and 401ks who are looking to invest in income-producing real estate. What the crowdfunding platform does is give investors access to those real estate investment opportunities, as well as the potential to invest in smaller increments, such as $25,000 at a time. That incremental investment allows an individual to build ownership in a portfolio of real estate properties within their self-directed IRA.

“I think the experience of the downturn and the flash crash distrust of Wall Street has driven the American investor mindset that they don’t want to be so reliant on the public markets. They want to diversify beyond the stock market as their sole source of investment opportunities,” says Powderly. In addition, investors are feeling better educated and have more tools at their fingertips to make their own investing decisions, he adds.

One benefit to using a self-directed IRA to buy and sell real estate is that the capital gains taxes are deferred until the individual starts withdrawing funds—ideally, after the age of 59 and a half, when he or she can do so without also having to pay an early withdrawal penalty. The tax situation is even more favorable for those individuals who set up a self-directed Roth IRA, which allows them to avoid additional taxes on the back end when they start withdrawing funds. The downside to self-directed IRAs is that individuals are taking more risks and relying on their own judgment to make sound investment choices.

It remains to be seen how large the self-directed IRA niche will become as word spreads that individuals can use their IRAs to buy things other than stocks, bonds and mutual funds. However, self-directed IRAs will continue to be a bigger source of capital for alternative assets such as real estate. “There is more money in IRAs at an increasing rate than any other pockets of capital,” notes McCartan.


To Your Successful Retirement!

Michael Ginsberg, JD, CFP® 


The 3 Key Numbers To Know for a Successful Retirement

If you start early, it’s easier to make your strategy work. Here’s how to figure out where you stand.

Retirement calculations are all about the numbers. How big will your nest egg be? How much money will you need to earn in retirement to maintain your pre-retirement standard of living? What type of investment returns should you plan for? How long will you live? Lee Eisenberg even wrote an entire book several years ago about “The Number.”  

Let’s restrict today’s numbers to three key figures: 1) the percent of your pre-retirement income you will need to maintain your current standard of living during retirement; 2) the amount of money you will need to sock away to achieve this replacement rate, and 3) how much you can pull out of your portfolio each year and still have a good shot at not outliving your money in retirement.

The Center for Retirement Research at Boston College just issued a study that took a crack at the first two items. It said middle-income retirees should adopt retirement-income targets that would replace 71% of their pre-retirement incomes. To do so, they would need to augment their Social Security and other pensions with contributions to their private savings that would average 15% of their pay if they began saving at age 35 and retired at age 65.

The comparable figures for low-income earners were an 80% replacement rate and an 11% savings rate. This is mainly because Social Security’s progressive benefit structure replaces a higher percentage of pre-retirement income for lower earners. On the other end of the scale, high earners were found to need a replacement rate averaging 67% and a 16% private savings rate.

We could endlessly debate whether these replacement rates and savings targets should be a few percentage points higher or lower. But while some financial advisers may base client strategies on income replacement rates, I have never interviewed a retiree who did so. These numbers are just guides, so don’t get carried away with them.

The big point is that we need to save a lot and to start at early ages. And we’re not saving nearly enough. A second major point of the CRR research is that continuing to work past age 65 can erase a lot of the savings shortfalls for those who haven’t set aside enough.

For example, if that typical middle-income earner doesn’t begin saving for retirement until age 45, she would need to save on average an implausible 27% of her income to permit her to retire successfully at age 65. If she continued working to age 67, that saving rate would fall to a still-unlikely 20%. But if she kept working until age 70, she would need to save a realistic 10% of her salary to maintain her standard living in retirement.

If you have been a dutiful saver, or even if you haven’t, you still need to figure out how to spend down your nest egg. Such discussions often begin with what’s called the 4% rule, which will celebrate its 20th birthday this October.

Developed in 1994 by financial planner William Bengen, it said nest eggs had a good shot at lasting for 30 years if a person began by pulling out about 4%t of their savings in the first year. Whatever number of dollars that represented would determine each successive year of dollar withdrawals plus an adjustment factor to keep pace with inflation.

In a recent study comparing different retirement drawdown strategies, the American Institute of Economic Research said of the rule, “For a rough estimate of how much is needed for retirement, it’s not bad. But no simple financial rule can take into account the complexity of real life.”

Bengen himself says as much. “For most people, to be perfectly honest, applying a 4.5% rule is probably not wise, even dangerous, because there are very simple assumptions that I used to develop that rule,” he said in a radio interview last year.

AIER, an independent non-profit in Massachusetts, ran a slew of retirement spending scenarios that involved variations of withdrawing a constant amount of dollars each year, a constant percentage of nest egg assets or an increasing percentage of assets. This last approach is based on the notion that adverse investment returns are especially damaging during the early years of retirement.

Withdrawing smaller percentages in those early years can help minimize nest-egg depletion (but it would have been scant protection from the Great Recession’s market plunge). You then can afford to withdraw larger percentages in later years primarily because your savings will need to last fewer years as you get older.

After producing nearly 100 combinations of drawdown approaches, dollar and percentage amounts, AIER was refreshingly candid: “There is no winning strategy.” Bad market conditions can ruin even the most prudent drawdown plans. Booming markets can make lunkheads look like geniuses.


To Your Successful Retirement!

Michael Ginsberg, JD, CFP®