Tag Archives: 401k

How Much Do You Need to Save for Retirement?

In the financial advisory business, one of the most pressing and controversial topics is how much money people need to save during their working years in order to provide for long-term retirement income.  The research on this topic has evolved quite a lot in recent years, and a recent issue of Money magazine features a series of articles representing the current view on this critical topic.  These articles, based around interviews with a number of the current thought leaders on this topic, deserve to be widely read and discussed.

The series of articles in Money kicks off with perspectives by Wade Pfau.  Pfau’s introductory piece suggests a difficult future for American workers.  A traditional rule-of-thumb in retirement planning is called the 4% rule.  This rule states that a retiree can plan to draw annual income equal to 4% of the value of her portfolio in the first year of retirement and increase this amount each year to keep up with inflation.  Someone who retires with a $1 Million portfolio could draw $40,000 in income in the first year of retirement and then increase that by 2.5%-3% per year, and have a high level of confidence that the portfolio will last thirty years.  It is assumed that the portfolio is invested in 60%-70% stocks and 30%-40% bonds.  The 4% rule was originally derived based on the long-term historical returns and risks for stocks and bonds.  The problem that Pfau has noted, however, is that both stocks and bonds are fairly expensive today relative to their values over the period of time used to calculate the 4% rule.  For bonds, this means that yields are well below their historical averages and historical yields are a good predictor of the future return from bonds.  The expected return from stocks is partly determined by the average price-to-earnings (P/E) ratio, and the P/E for stocks is currently well-above the long-term historical average.  High P/E tends to predict lower future returns for stocks, and vice versa.  For a detailed discussion of these relationships, see this paper.  In light of current prices of stocks and bonds, Pfau concludes that the 4% rule is far too optimistic and proposes that investors plan for something closer to a 3% draw rate from their portfolios in retirement.  I also explored this topic in an article last year.

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Review of Pound Foolish by Helaine Olen

I have been hearing a lot about Pound Foolish: Exposing the Dark Side of the Personal Finance Industry, by Helaine Olen.  Without having read the book, it sounded like a muckraking survey of the ways that the financial services industry fleeces individuals. Commentators in the financial services industry have been broadly critical of the book.  Larry Swedroe, a well-known advisor and journalist concludes that “problems are well exposed, but investors are left in the dark about how to deal with those issues. This book has many positive aspects, but in the end, it comes up short of helpful.”  Morningstar’s John Rekenthaler comes to a similar conclusion in his review, suggesting that the book is entertaining and worth reading, but is somewhat biased in terms of telling Olen’s audience what they want to hear.  The reviews and controversy inspired me to read the book myself, and it is a fairly quick and enjoyable read for those interested in the issue.  Continue reading

The Collapse of the American Net Worth

Many of you are painfully aware of how many friends or family members are out of work, now under-employed, or who have lost their homes. Geoff Considine, a leading contributor to the Portfolioist, provides his take on what we’re calling the “collapse” in household net worth, starting with a recently published report released from the Federal Reserve called the “Survey of Consumer Finances” (SCF).

This study, performed every three years, provides an analysis of household income and wealth across America, and the results will astound you. The SCF is well-worth reading if you want to get a handle on the state of Americans’ finances—especially if you want to see how those same finances have changed dramatically in just three short years. Continue reading

How Much Risk Should A 65-Year-Old Take?

Stacy Schaus, Executive Vice President at PIMCO and her colleague, Ying Gao, recently wrote a white paper titled, “Loss Capacity Drives 401(k) Investment Default Evaluation” that tackles some of the most important issues in retirement planning. The white paper discusses the development of asset allocation strategy over an investor’s working years and into retirement. (Schaus has worked on this problem for years and has written a book called Designing Successful Target Date Strategies for Defined Contribution Plans: Putting Participants on the Optimal Glide Path on this topic).

While the white paper covers a number of elements of the life cycle asset allocation problem, I’d like to focus on one in particular: How much can a 65-year-old investor approaching retirement really afford to lose? Continue reading

Are 401(k) Fees Consuming 30% of Our Lifetime Savings?

There is a story getting considerable coverage this week about a study that finds that an average family may end up having 30% less in total lifetime accumulated wealth in their 401(k) plans due to high fees and expenses. The study inspiring all of this attention is titled “The Retirement Savings Drain” and published by policy research firm Demos.

The Demos study estimates that the all-in costs of a 401(k) plan, (including fund expense ratio, trading costs and administrative fees) average 1.56% of assets per year. This figure is based on asset-weighted average expense ratios for mutual funds and assuming trading costs that are pretty reasonable. The all-in cost estimates are fairly consistent with other estimates that I have read. Participants in large low-cost plans may pay less and participants in small company plans tend to pay Continue reading

The Big Retirement Shift: From Saving Up to Drawing Down

The financial services industry is in a period of substantial change.  Low interest rates, new regulations and additional scrutiny are changing the landscape.  Perhaps the biggest change is the transition of the first wave of Baby Boomers from working to retirement.  Not only is this generation huge, but its also the first “401(k)” generation. The  introduction of self-directed retirement accounts, such as 401(k) plans, coincided with the “Baby Boomer Generation” (people born between 1946 and 1964) entering their peak saving years.

Beyond the 401(k)

The 401(k) plan was first introduced in 1980.   In 1980, the oldest Boomers were 34 years old and entering the age range at which people really start to save.  Not surprisingly, the financial services industry created a multitude of new financial products to pitch to these people.  Thus began the era of the mutual fund. Continue reading

New Study Released: How Much Americans Need to Save to Retire

The Center for Retirement Research at Boston College recently came out with a new analysis of how much Americans need to save in order to be able to maintain a reasonable lifestyle in retirement.  Published in November 2011, the report is titled “How Much to Save for a Secure Retirement.”

The study starts with an assumed target “replacement rate” that represents the fraction of pre-retirement income that an individual will be likely to need to maintain their lifestyle in retirement.  A long-term project at Georgia State to estimate required replacement rates provides the numbers that serve as the foundation of the CRR paper.  The Georgia State research suggests Continue reading