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The Nest-Egg Blues
By:
Ellen Graham
After a lifetime of working, saving and planning -- and almost two decades of unprecedented economic prosperity -- many people should be sitting pretty as they approach or enter retirement. Instead, nest eggs have shriveled in the stock-market swoon. Incomes are dwindling, thanks to measly interest rates. And after Sept. 11 and the Enron scandal, there are fears that other shoes are about to drop. It's attitude-adjustment time for older Americans. Their luck has turned, and now many have a bad case of the jitters. Retirement security? More and more, that sounds like an oxymoron. The country may be climbing out of recession, but will recovery be robust enough to banish the traumas of the past couple of years? For tips on how to regain financial and emotional equilibrium in scary economic times, The Wall Street Journal convened a panel at the Wharton School at the University of Pennsylvania. The participants were: • John
L. McKeever III, a chartered financial consultant with McKeever Burke &
Grant in King of Prussia, Pa. The interview was conducted by Ellen Graham. Tighten Your Belt The Wall Street Journal: John, you talk to clients every day. How are they bearing up? Mr. McKeever: It depends on their comfort with investing. In the late '90s, a lot of people were lured into a false sense of security with an unbelievably hot economy and market. They weren't content with traditional returns, they didn't want to hear about asset allocation, bonds or value investing. I believe it was in '99 when 97.5% of 401(k) equity money was invested in large-cap growth funds, and it all went over the cliff together. So, if you're 58 years of age and you stayed in those large-cap growth funds, you've lost about 20% to 22% of your money in the last couple of years, and you're thinking, "I may not be able to retire." WSJ: What if you're already retired? Mr. McKeever: Then you're really anxious. You don't have the ability to replace the lost funds as easily. So you tighten your belt and lower your standard of living. You reallocate your assets -- a generic rule of thumb for older investors might be one-third bonds, one-third value funds and a third growth investments. Maybe you go back to work for a while. Prof. VanDerhei: Among current workers in the Employee Benefit Research Institute's January 2002 retirement confidence survey, fully two out of three expect to be working at least part time after retirement, whereas only 24% of today's retirees are working. WSJ: In light of the risk of new terror attacks and lingering questions about corporate balance sheets post-Enron, should people consider altering their savings and investment strategies? Prof. Mitchell: The best overall plan still should be to save more, diversify investments, keep commissions and fees down, retire later, and don't underestimate your longevity [in planning]. People will better protect themselves this way than by trying to time the market or actively select individual stocks. Prof. VanDerhei: If people believe that the balance-sheet "anomalies" are truly widespread, they may want to cut back substantially on equities and perhaps even corporate bonds. Otherwise the only change to consider is more diversification. The less you have in any one stock, the less a single Enron-type incident can impact your portfolio. One of the most interesting results of 9/11 from a financial perspective was that the impact on the stock market turned out to be relatively mild. However, those who were heavily invested in individual stocks or sector funds still may not have recovered from some of the initial losses. Again, unless one is convinced that future terror attacks may be so severe as to result in nationwide economic disaster, [you might simply] treat this as a signal to increase diversification. WSJ: Have older investors made mistakes that got them in trouble? Or were some problems unavoidable? Prof. VanDerhei: I'm sure for some individuals the problems were of their own making. Overall, people in their 60s have only about 40% of their 401(k) portfolios invested in equities, and as they get closer to retirement, they tend to start going into much more conservative investments. In fact, guaranteed investment contracts and guaranteed-rate-of-return allocations are now up to nearly 20% of the asset allocations for that age group. Obviously some individuals expose themselves to more risk. But I'd caution against looking too closely at short-term volatility in the market. A bad year or two shouldn't necessarily make you give up on what might be an excellent strategy for the long term. Prof. Mitchell: At retirement there are two issues people should be doing a better job with. One is the risk of living too long and running out of money. My concern is a lot of the Web-based financial-planning programs don't alert you that you shouldn't merely be trying to finance living to your [projected] life expectancy. You may well live 15 years beyond that. I always try to set longevity up to 100, but many of the programs won't let you do that. The other risk we haven't focused on much lately is inflation. In the '70s and '80s, inflation was dominant in everybody's thinking. Most pensions didn't pay inflation-protected benefits; they just eroded over time. There are now products available that help protect against inflation -- in particular, inflation-indexed bonds. They aren't expensive and are returning a good rate, but getting the older generation to look at these is a struggle. Inflation has been low for some time, and we have short memories. This is myopic. Mr. McKeever: I tell clients if we're guilty of anything, it's helping our children too much. When retirees come in, they have only two things on their minds: Do I have enough money, and will I be dependent on my kids? If you don't want to be dependent, don't give too much money away -- to kids, to charities or to bad investments. Boats -- a terrible investment. Biggest Goofs WSJ: What is the worst flaw you see in the portfolios of older adults? Mr. McKeever: The people we see, especially here in the East, whether they think they're smarter or they're more aggressive investors, didn't want to hear anything about fixed assets. If they'd had more balance in their portfolios, they'd be fine. But now the problem is they again want to jump on what's hot -- small value and big-cap value. And it's like a Ferris wheel -- what's at the top will go to the bottom; what's at the bottom will come back. Prof. VanDerhei: The major problem we've seen is how many people in their 60s have just completely left the equity market. Of the 401(k) participants that age, nearly 42% don't have a penny in equities. So they're not looking at the bigger picture -- how to ensure adequate income for 15, 20, 25, 30 years. WSJ: Don't we have a split here? John's East Coast investors have been overly aggressive, while your database shows conservatism to a fault. Prof. VanDerhei: I would suspect that the salaries of those I'm looking at and the kind of individuals going to John are different. Certainly, we find among higher-income individuals much more aggressive equity participation. WSJ: Do most people lack the expertise to be do-it-yourself retirement planners or financial managers? Prof. Mitchell: Most people who are retiring today, let's be clear about it, are probably not sitting on a big 401(k) plan. They probably have a defined-benefit pension, and the employer is making most of the investment decisions. But we just did a survey on how people perceive the risk of different kinds of investments in their 401(k) portfolios. The buying and holding of individual stock was seen as very risky. But the interesting part is they saw buying their own company stock as quite a bit safer than buying anybody else's individual stock. Particularly given recent Enron revelations, 401(k) savers should reassess how much company stock they can comfortably hold, in light of the higher risk this exposes them to. Financial illiteracy can be costly. Balancing Efforts WSJ: Do retirees spend too much time micromanaging their money, or don't they give it enough attention? Prof. VanDerhei: With 401(k) plans, it's remarkable how stable they are. You find that once an employee has chosen his or her asset allocation, even with what we've seen going on in the last five years with the national markets -- they keep that same allocation year after year. Most people should consider rebalancing as financial markets change; only about a quarter of them do. Mr. McKeever: We do annual meetings on all of the 401(k) plans we manage. The people who come to the meetings are the lower-paid employees. The executives are too busy -- classically, in the law firms none of the partners come. They're the ones who want the growth. They're the ones who buy the stocks. They're the ones who don't pay attention to the stocks. They're the ones who come in at retirement and say, "Look at my account, it's not worth nearly as much as it should be." Prof. Mitchell: I think that in planning for retirement, most people have either explicitly or implicitly been told, "There, there, don't worry, somebody else will take care of you" -- be it the government through Social Security and Medicare, or your employer through your pension and retiree health insurance if you're lucky enough to have that. And that's a very different message than people are being given right now. Much more responsibility is being shifted onto the individual's shoulders, and it takes a lot of work. It's like what Oscar Wilde called the problem with socialism: It takes too many nights and weekends. Surprise Expenses WSJ: In planning for retirement, which expenses do people typically underestimate? Prof. VanDerhei: Well, absolutely tops is long-term care -- and the need to start financing it while you're still working. This is an expense that I would think, if you go back a generation, absolutely nobody would have thought about. Prof. Mitchell: Many employers are now offering long-term care insurance -- not just for their employees, but for workers' parents. [The employers] aren't paying for it, but they're offering access to a risk pool. Mr. McKeever: The biggest surprise is the cost of health care. If someone retires early or is let go, and isn't yet eligible [for Medicare], health insurance can cost $10,000 to $12,000 a year for a couple. And that's maybe without any pharmaceutical benefits. Prof. Mitchell: [If you are] in your 50s or 60s, a very important predictor for being healthy later is your investment in your health right now. I think a lot of people in later middle age give up and say, "Well, I'm already old, there's no point in trying." WSJ: You're suggesting that taking care of yourself is a form of financial savvy? PROF. MITCHELL: Absolutely. If you want to be healthy and happy when you're 90, then get out there and walk when you're 50. Spending Patterns WSJ: Must spending patterns inevitably change in retirement? How do you strike a balance between frugality and extravagance? Mr. McKeever: You need to look at only two things -- wants and needs. Your needs are your health insurance, your mortgage, food and a few other things. You don't need many new clothes at this point, or perfume. It's the wants that get you into trouble. You can have a tremendous income and sometimes still not have enough money. One fellow recently told me, "I don't want to sell any one of my three homes." I told him he had to sell one if they were going to retire sensibly. So they did. But it was a struggle. WSJ: How do you create a steady income stream once you have retired? Prof. VanDerhei: If you don't annuitize, the question becomes how much can you safely take out each year. It depends on your assumptions of future investment income and, most important, on how conservative you are about life expectancy. If you calculate you'll live to 100, you'll be safe, but you'll have less to spend annually, and chances are you'll leave behind more when you die. This is why people buy annuities -- you're pooling life expectancies and sharing the risk. Mr. McKeever: You want to look at annuities carefully. Often you can do better by drawing money down periodically from your own investments. Have an accountant run the numbers. PROF. MITCHELL: A lot of people have substantial equity in their homes that can be a source of financing for retirement. But most people don't downgrade [housing] when they move in retirement. They move laterally or buy up. House Dreams WSJ: What motivates people in their 60s to build the biggest house they've ever had and furnish it lavishly? Prof. Mitchell: Well, housing is a good investment -- at least in this country. In Tokyo, housing has been an abysmal investment; prices have fallen 60% over the last decade, and that certainly challenges retirement policy in Japan. WSJ: Could that ever happen here? Prof. Mitchell: Sure, if all the baby boomers all of a sudden try to unload their houses, that could well depress values. And, in fact, one of the things that concerns me is that housing is so undiversified. Many people have put every penny they have into building up that mortgage and increasing the size of their house. So if that's a major part of your retirement portfolio, diversifying and getting out of such a big house is probably a good idea sooner rather than later. Mr. McKeever: I'm a big believer in leveraging your money with mortgages while you're working, not necessarily when you retire. Prof. VanDerhei: Nationally, over 60% of families age 65 and over own their house free and clear, and their median home equity is $85,000. But it's almost impossible to predict what's going to happen to housing values in a particular area. What our parents' generation received in [housing] appreciation is very unlikely to happen again. You just don't have enough people following you to buy those houses to give you the likelihood of capitalizing to the same degree. Happiness Is ... WSJ: John, you have spoken of observing an inverse correlation between great wealth and happiness. Mr. McKeever: I absolutely see it again and again. Some of my clients who are truly wealthy tend not to trust their children's intentions. I have several who are very, very skeptical of anybody who wants to be their friend. They have their defenses up all the time. Some of my happiest clients are retired professors who have managed their money well. Maybe they didn't have the stress of the business world, so they're healthier. Other fellows who had to make a lot of money spent half their time in planes in bad air and didn't take care of themselves. And when they retire, if they don't have a lot of interests, they're pretty unhappy. But if people have lived within their means and they're organized, switching gears in retirement is a nonevent. [That's] because they have their act together, they know what their cost of operations or budget is, they know where the income's coming from. If they're blessed with good health, they have a nice retirement. And they usually don't retire -- they're too busy. FAIR USE NOTICE: This page contains copyrighted material the use of which has not been specifically authorized by the copyright owner. Global Action on Aging distributes this material without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. We believe this constitutes a fair use of any such copyrighted material as provided for in 17 U.S.C § 107. If you wish to use copyrighted material from this site for purposes of your own that go beyond fair use, you must obtain permission from the copyright owner.
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