About three years ago, a lot seemed to be going right for America's investors. The economy was growing rapidly, and investment asset values were soaring. Some business owners were retiring earlier than they had previously expected while many others were planning to do so.
The situation now is dramatically different. The bear market, by some measures the most damaging since the Great Depression, is now starting to force business owners within 10 years of retirement to reassess their situations. Retirement nest eggs have declined sharply in value. And risk-free income has shriveled because of plummeting short-term interest rates.
From 1926 through 2002, the stock market produced a 10.5% average annual return. Long-term government bonds returned 5.5%. But it is far from certain if future investment returns will match those averages. In fact, it is possible that, for the first time in 70 years, investors will face four consecutive years of stock-market losses: 2000-2003.
While it may be necessary for most people to lower their financial expectations, you can still achieve retirement security. Here are some important steps to take:
#1: Save as much as you can. To reach financial independence, you need to live well below your means. Curb your spending. Save at least 10% of your annual income, and preferably 20% or more, depending on your current income and future needs.
Make maximum contributions to "qualified" retirement plans. With a 401(k), IRA and other employer plans, you cut your tax bill immediately, and plan earnings will grow free of tax until you withdraw the money.
#2: Invest according to your needs. It is essential that you determine when you will want to tap your nest egg for living expenses. If you have plenty of time until then, you have more flexibility to invest for long-term growth. But if you have just a few years until you start to draw on your assets or if you are already doing so, you need to minimize your overall risk.
#3: Stay selectively diversified. Many growth stocks and have faltered badly, along with shares of conservative, "safe" stocks. When you spread your investments carefully among different types of stocks and equity mutual funds, as well as bonds and cash, you keep your losses down in tough markets while continuing to build your wealth over the long term. Limit each position to a modest percentage of your nest egg, such as 10%.
#4: Keep your investment expenses down. With long-term returns likely to be more moderate, these can make quite a difference in your investment return. While you cannot guarantee how your investments will fare, you can control how much you pay for them.
Suppose you have a $250,000 portfolio. If you net 7% a year on your investments, $250,000 will grow to $491,787 in 10 years. But if you can keep 1 percentage point more by watching your costs, you will automatically keep an extra $2,500 the first year. If you reinvest each year's savings and earn an 8% net return on your investments, you'll end up with $539,490--9.7% more.
#5: Consider whether you will need to work a few extra years. Delaying your retirement gives you more time to save and more time for your nest egg to grow. An increasingly popular way to retire is to work part time. If you cover your living expenses, your entire nest egg can keep growing.
If you delay tapping your portfolio three years and your investments earn 8% annually, you will typically need about 15% less to retire. You may boost your Social Security retirement benefit too: You get a 4.5% increase after age 65 for each year you wait to start collecting benefits.
#6: Look at the possibility of trading down to a smaller home or relocating to a lower-cost area. If you sell your current residence, you can avoid tax on up to $500,000 of profit from that and previous homes ($250,000 if you are single). You may be able to invest a good part of the sales proceeds. You will also save on property taxes, insurance, utilities, maintenance and possibly mortgage payments.
Philip A. Springer, president of Retirement Wealth Management, Inc, is a national authority on building and enjoying a rich retirement. Retirement Wealth Management specializes in the investment needs of people who are approaching retirement or already retired. He has written extensively about retirement investing, spoken at many investment conferences and been quoted in numerous publications.