Going back in time to understand retirement investing today
Retirement (and retirement planning) has changed rapidly over the past few generations. At some level, most investors understand this. But I’d be willing to bet that you’ve had conversations with clients who just don’t understand why the way their parents and grandparents saved for retirement won’t work for them.
Taking a moment to satisfy your clients’ desire to “look back” can actually help them understand what has changed and set up a conversation about the realities of retirement planning today. So let’s gear up our time machine and pay a visit to a hypothetical family inspired by a real-life couple I recently met at a family reunion.
Set your clocks for 1962: Ernie and Liv
It’s 1962 and Ernie and Liv are a married couple in their early 40s with four kids. Liv is a telephone operator—a career she will maintain until she retires at 65. Ernie is a Navy man turned government employee who will retire at 55.
Throughout their lives, Liv and Ernie owned a home and did their best to save, but they had very few investments. They paid off their mortgage before retiring and once they retired, they received full pensions from their employers plus Social Security income.
Thanks to these pensions and Social Security, Ernie and Liv received a check for approximately $4,200 every month from 1985 to 2014. That $4,200 of monthly income meant they were set to do what they pleased in retirement (which happened to be driving the West Coast in search of golf courses and open water to sail). Their “number,” or the amount of income they needed to sustain their retirement, was calculable and guaranteed. Ernie and Liv were able to live out their retirement comfortably and without concern around whether they would have enough.
Set your clocks for 2016: Julia
401(k) plan average asset allocation, percentage of total assets, 1996 and 2013
|GIC/Stable Value Funds||16%||7%|
|Source: Employee Benefit Research Institute. (January 1999). 401(k) Plan Asset Allocation, Account Balances, and Loan Activity. (December 2014). 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2013.|
Back to the future: It’s 2016 and Ernie and Liv’s granddaughter, Julia, is in her early 40s and working in technology. She is married with two young children and like generations before her, Julia is in her peak earning and peak spending years — but with a new twist. The onus is entirely on Julia to fund her retirement and potentially care for her parents in old age (and if trends being set by millennials continue, perhaps her children when they move home after college!).1
So much has changed in the 50 years separating Julia and her grandparents. Julia knows just one friend with a defined benefit plan, similar to the pensions her grandparents had. This seems in line with the fact that as of 2015, only 25% of employees who participated in retirement plans through their medium and large-sized private firms were enrolled in a defined benefit plan. By comparison, that figure was 84% in 1980.2
Instead of a defined benefit plan, Julia has a 401(k) — a defined contribution plan in which she manages her own contributions, investments and distributions. Julia is a little confused by the large number of investment options available in her plan and she’s not entirely sure she’s contributing enough. Julia isn’t alone in this: At year-end 2013, the average defined contribution plan balance was just $72,383.3 While many DC plan participants nearing retirement may have higher plan balances, this average still suggests that many investors may not be tracking toward a financially secure retirement.
While her grandparents worked nearly their entire careers for the same employers, Julia has already worked for four companies and knows that number is likely rise to nearly a dozen in her lifetime. And while her grandparents could count on a Social Security check in the mailbox each month, Julia has heard that Social Security benefits are only expected to be payable in full until 2037 — several years before she will likely be able to retire. 4
Julia also knows that she is likely to live longer than her grandparents, which is wonderful and challenging at the same time. In 1980, the life expectancy for a 65-year-old woman was an additional 18.8 years. By 2020, that figure will be 22 years — three more years of retirement to be funded.5
In addition to these changes, today’s globally integrated investment landscape is infinitely more complex than the one Julia’s grandparents knew. Just look at how the average 401(k) participant’s asset allocation has changed from 1996 – 2013 (Table 1). Investing in individual stocks and bonds, let alone a simple savings account, likely isn’t enough to generate the returns Julia needs to fund her retirement. Now there are mutual funds, alternative asset classes, real assets, active, passive… and so many other investment choices to be made.
All in all, finding her retirement income “number” seems like an utterly overwhelming concept to Julia. What is she supposed to do?
Understanding what has changed and where to focus now
There’s no doubt that your clients like “Julia” are facing challenging questions around ensuring they have the retirement income they need. That confusion might be heightened by frustration with how well the “system” seemed to work for previous generations.
When this frustration strikes, help your clients understand how our world, our lives, and our approach to retirement investing has changed and how they can refocus on what is within their control, such as:
- Saving early, saving often, saving much – The impact of compounding is undeniable. One of the best things investors can do today is actually acting today and not waiting to save or contribute.
- Making investments work as hard as possible – Investing today requires a different approach than in previous generations. Employing a diversified, multi-asset investment approach can be a powerful strategy in managing risk and pursuing global investment opportunities.
- Discovering their retirement income “number” – This is complex but with the help of a financial professional, investors can estimate their income needs in retirement and evaluate whether they are on track to meet those needs. Help your clients understand the tools at their disposal and how this “number” can help guide planning decisions.
1 Source: More Millennials Living with Family Despite Improved Job Market. July 29, 2015.
2 Source: EBRI Databook on Employee Benefits Chapter 5: Private- and Public-Sector Retirement Plan Trends. October 2015.
3 Source: Employee Benefit Research Institute. (2014, December). 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2013.
4 Sources: Bureau of Labor Statistics. (2015). Number of Jobs Held, Labor Market Activity, and Earnings Growth Among the Youngest Baby Boomers: Results From A Longitudinal Survey. ; The Future Financial Status of the Social Security Program. Social Security Bulliten. (2010).
5 Source: Falling short: The coming retirement crisis and what to do about it. Center for Retirement Research at Boston College.
The circumstances of the individuals described in this post are hypothetical and included for illustrative purposes only.
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