Investing to help achieve long-run goals

By William Creekbaum

For most investors, funding a secure retirement is a primary financial consideration. For many investors, pay for their children's tuition costs comes a close second. Reaching these objectives, however, requires careful planning and an acute awareness of the many obstacles investors face - such as inflation, market uncertainty and the difficulty of making long-run financial projections.

To help clients better understand these crucial subjects, Consulting Group recently sponsored a conference call with Dr. Richard Marston, director of the Institute for Private Investors program at the University of Pennsylvania's Wharton School of Business, and an advisor to Citigroup's Global Wealth Management Investment Strategy Committee.

I have provided some of the questions and answers during Dr. Marston's presentation and his responses to some of the questions asked by Smith Barney Financial Advisors and their clients.

As Life expectancies increase, how does that influence retirement planning?

The typical investor's life expectancy is much longer than is commonly appreciated. Americans are also retiring earlier than they once did. According to the Labor Department, the average woman now retires at age 61 and eight months, while the average man retires at age 62. Based on current life expectances, the average 62-year-old man will live until 85.

Twenty-five percent of them will reach age 92. Women tend to live longer, so 25 percent of 62-year-old women can expect to reach age 94. This means the typical retirement may last more than two decades, and a significant number might last 30 years or more. And life expectancies continue to rise. So the good news is we are retiring early and living wonderfully long lives. The bad news is we have to find a way to pay for them.

What does that imply about retirement strategies?

The first thing investors need to understand is that they should base their retirement calculations on real or inflation-adjusted returns, not nominal returns. When you're contemplating a 20- or 30-year retirement, you have to worry about the very substantial cumulative effects of inflation.

Even an inflation rate of just 2.5 percent will translate into a 28 percent increase in the cost of living over 10 years, and a 60 percent erosion in purchasing power over 20 years. So what looks like an adequate return may not be sufficient, once future inflation is taken into account.

What could that mean for the typical retiree's standard of living?

Let's use the example of a 50-year-old married couple making $100,000 a year before retirement. We'll also assume the couple hopes to maintain 90 percent of their pre-retirement income, which is $90,000 before taxes. However, if you're budgeting for $90,000 in today's dollars, you're chasing a moving target in terms of future income because of inflation.

If we assume the inflation rate is 2.5 percent, how much income will our 50-year-old couple need to equal their $90,000 target in today's dollars? The answer may startle you. At age 62, the couple would need $121,000 to maintain their desired standard of living. At age 67, they would need almost $137,000.

How can retirees develop realistic spending plans?

It's useful to plan on the basis of a defined spending level, usually expressed as a percentage of available assets. Given the resource constraints most retirees will face, it's probably prudent to budget for annual spending equal to 4 percent or at most 4.5 percent of their invested assets. However, there are no hard and fast rules.

How much do retirees need to save to support their desired post - retirement standard of living?

Let's look at our previous example - a couple hoping to retire on an income of $90,000 a year. Remember, their budgeted spending is between 4 percent and 4.5 percent of portfolio value. That means this couple is going to need accumulated assets of almost $1.6million to reach their goal - including Social Security benefits. If they postpone retirement to age 67, the required amount drops to $1.4 million. Keep in mind that those goals are expressed in terms of today's dollars. So the actual amounts required would be much larger. Small wonder we have a looming retirement crisis in this country.

Can postponing retirement for a few years make a significant difference in available resources?

It is advantageous to postpone retirement, for three reasons. First, investors can add to their retirement savings at a time when, in most families, college tuition costs are behind them. Secondly, assets can continue to grow because the portfolio is still generating returns without offsetting spending. Finally, delaying retirement until age 67 increases Social Security benefits.

Those are pretty powerful reasons, which is why I think we will see more and more Americans working into their late 60s or even longer.

Can investors improve their chances of reaching their retirement income objectives?

Yes, but only if they're willing to accept a higher exposure to equities. Bonds may help you sleep better at night but that's because you're not focusing on the nightmare of not having enough to retire on. That's the risk investors ought to be thinking about, not the risk of short-term market fluctuations. It's important to choose a portfolio that emphasizes long-run accumulation and that means a commitment to the equities.

For a full copy of Dr. Marston's report, e-mail me at William.a.Creekbaum@smithbarney.com or call 689-8704.

• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial services firm serving Northern Nevada at 6005 Plumas Street, Ste. 200 Reno, NV 89509.