7 Essential Truths for a Successful Retirement
Whether you are in your 20s, 50s, or somewhere before, beyond, or in between, you may find yourself concentrating on the complexities of financial planning. While that effort may be valuable in weighing the advantages of a Roth IRA vs. Traditional IRA, mutual funds vs. ETFs, and more, too much analysis can thwart the task of seeing the forest as you focus on the proverbial trees.
As a result, you may unintentionally ignore the basics. Consider these seven essential truths that are the foundation of a successful retirement. (See also: 7 Tips for Stress-Free Retirement Investing)
1. Consistent Frugality Trumps (Attempts at) Great Investing
This truth comes from Jonathan Clements, former personal finance columnist for The Wall Street Journal who now works as the director of financial education for a large financial institution. In his years of interacting with readers and customers, he tells me that those who practice simple frugality routinely enjoy more prosperous retirements than those who pursue greater investment returns.
Obviously, great investing — getting a higher return rather than a lower one — is desirable. An earlier start and higher levels of savings, though, can trump higher returns. For example, if you set aside $5,000 per year and earn 5% per year as a 25-year-old, you will have more than $600,000 at the retirement age of 65 years; however, if you get investment returns of 8% per year but save just $3,000 annually and get a later start at 35, then you will have less than $350,000 upon retirement.
Clements’s stance is based on real-life observations, not just theoretical financial projections like mine. In his experience, putting energy and effort into diligent saving (even as an average investor) is more beneficial to a successful retirement than being a great investor.
2. Automation Is Your Retirement Friend
Automation helps you to avoid agonizing about investment decisions on a regular basis. This approach also helps you to avoid inaction and overspending.
You do have to set up the accounts, determine monthly contribution dollars, and select investments. But automation means that money will be diverted from your paycheck and checking account to investment accounts without further analysis and anguish.
Then, after paying bills, you are free to spend what is left in your checking account. You will have a solid mental picture of your discretionary income and won’t fool yourself into thinking that you’ll set aside retirement savings next month after you buy a few items on your wish list this month.
Over a working lifetime, you can amass wealth by automating contributions to several types of accounts.
- Roth IRA
- SEP-IRA (if you have self-employment income)
- Traditional IRA
- Regular savings account (for shorter term needs, which helps to avoid borrowing from your 401(k) or taking money out of your Roth IRA)
- Health Savings Account (if you have a high-deductible health plan that is HSA-eligible; savings not needed for health needs can be taken as income in retirement)
3. Be Disciplined or Pay Someone to Keep You Disciplined
According to Clements, most people have the knowledge to save money and invest sensibly or can easily acquire the basic tools to prepare for retirement. However, they often lack the discipline to make rational decisions with their money.
You may understand the investment concept of buying low and selling high, or similarly, know how to shop for a bargain rather than paying full price for a designer outfit or digital gadget. Still, you might become overly excited and purchase an investment when its price is soaring or panic and sell off investments during a stock market decline. Such emotional reactions can be counterproductive to creating wealth.
A good financial advisor can not only design a portfolio of investments, but also keep you from buying high and selling low, calm your fears about risk, and encourage diligent saving.
In his novel "48 and Counting: A Story of Money, Love and Cycling," Clements provides a glimpse into the life of fictional financial advisor Max Whitfield, who manages $70 million of his clients’ money. He views his role in this way:
Max didn’t just manage a portfolio’s risk, costs and taxes. He also managed clients. In fact, that was how he spent most of his time…Keep clients invested when they were unnerved by plunging markets. Make sure they saved enough, didn’t go overboard on debt, bought the right insurance and had an estate plan.
So, if you find yourself routinely making bad financial decisions, even though you have the knowledge to make sound ones, consider engaging a financial advisor. And remember that the right person won’t advise you to chase a high-flying investment but will encourage you to take the necessary actions to build wealth over a lifetime.
4. Multiple Income Sources Can Prevent Disaster
We have heard many times, “don’t put all of your eggs in one basket.” And it’s true that diversifying investments is valuable to long-term financial planning. The idea is that a downturn in one area (say, the local real estate market) won't ruin you financially because you have other ways of making money (such as dividends from stocks).
In his book "How Much Money Do I Need to Retire?", Todd R. Tresidder, financial coach and former hedge fund manager, argues for diversification not only in terms of a diversified stock portfolio but among all assets that generate income. He states that:
...passive income must come from multiple, non-correlated sources. A reasonable mixture of TIPS, dividend paying stocks, income producing real estate, inflation-adjusting fixed annuities, and alternative investment strategies would satisfy that requirement. It’s also possible to mix in some passive business income, royalty income, Social Security income, pension income, and other sources...Never leave yourself exposed to a single default that can wipe out your financial security.
5. The Future Is Unpredictable
Most of us (including me) plan for the future based on how things have worked in the past. This approach can be useful if you consider that you will probably experience market downturns as well as upticks, have to deal with rising prices because of inflation or other causes, and pay taxes based on perpetually changing tax laws. So, planning based on uncertainty and unpredictability makes sense.
Making assumptions that the future will look precisely like the immediate past, though, is dangerous. As Clements explores in his book,
They [clients] couldn't accept that the future was unknowable and the past was a rotten guide to what lay ahead. They were betting their financial future. Chaos might be the reality, but it was emotionally unacceptable. So they assumed the future could be divined and that [financial advisor] Max had the inside scoop.
Several years ago, a financial advisor-sales consultant oversimplified the planning process and pretended that he could predict the future. He recommended that my husband and I invest a lump sum distribution in a certain set of mutual funds. He illustrated the future growth of our money based on the previous five years of fund performance. We didn't take his advice, but if we had assumed that the next five years would work exactly like the past five ones, then we would have lost a lot of money.
More sophisticated projections with longer timelines using average returns can also be misleading. Even though the average return of a 41-year-old portfolio may be 8%, you won't get a steady staircase of returns over this time frame but instead experience something akin to a switchback trail in which you move forward and backward as you make progress toward a goal.
Average Returns vs. Compound Returns
I found Tresidder's discussion about average returns vs. compound returns in his book enlightening. He explains that compound returns portray the reality of portfolio changes because they integrate market ups and downs. Note that compound returns are "always less than average returns because of the way money compounds. If you lose 20% one year and gain 20% the following year, your average return is zero but your account will actually lose money through compounding. In this example, your $100 account drops to $80 in the first year ((100 - (100 x .20)) = 80) and then rises to only $96 in the subsequent year ((80 + (80 x .20)) = 96)."
Understanding that returns (and the future) are uneven and unpredictable is essential to retirement planning.
6. Debt Can Weigh You Down
Debt in retirement could be manageable, but ideally, you should have no debt — not even a mortgage payment — when you retire. Sure, if your investments grow at a higher return than your loan interest rate, then the math may favor low-interest mortgage debt.
But the real problem with debt is that monthly payments increase your personal cost of living and may require you to spend down assets. You can't skip a mortgage payment in the same way that you might decide to forgo luxury seats at an NFL game to watch the game at a sports bar or skip dining at a fancy restaurant in favor of cooking at home. For example, you may need to:
- Take greater distributions from retirement accounts earlier, slowing growth in account balances.
- Accept Social Security payments or a pension earlier rather than later, possibly reducing the benefit amount.
- Tap sources of income during a downturn, which may deplete your retirement balances.
- Pay higher income taxes because you are generating more income from retirement distributions or other sources to cover your living expenses.
So, getting rid of debt prior to retirement can benefit wealth building and financial flexibility.
7. You Need a Plan for Meaningful Pursuits
Clements tells me that many people think of retirement purely as a time in which they will relax and enjoy time away from work. But absent goals and purpose, pure leisure becomes tiresome after a few weeks.
His book follows Max as he loses his wealth management firm in the aftermath of a midlife crisis, obsession with cycling, and extramarital affair. However, at 48, he becomes energized at the prospect of rebuilding a similar company.
Now that Clements brings up this topic, I can think of many people in their late 60s and 70s who have continued to work beyond the standard retirement age. Most, however, are not spending 40 hours each week at a traditional workplace. They are running a small business or doing some form of freelance work, such as selling artwork, coaching a high school sports team, organizing bus trips, or growing plants for sale.
Ken Eisold, Ph.D., elaborates on this idea of purpose beyond financial concerns. He says that, “on a personal level, those who keep working also often feel more useful and relevant. Unless retirees find stimulating and socially valuable activities, they undergo a kind of marginalization that makes it more difficult to maintain self-esteem and overcome depression.” So, when you are planning retirement, consider what challenges you’d like to tackle and not just the vacation home you want to have.