Building a better nest egg
Having enough to retire on is about more than just stocks
When the high-tech and dot-com hot air whooshed out of the overheated stock market a few years back, the hopes of would-be retirees also went flat. The market's comeback undid some of the damage, but many nest eggs still show cracks. Is it possible to get back on track relatively quickly? Or should people swallow their disappointment and scale back their retirement plans?
Probably some of both, say experts. Those on the cusp of retirement and short of their goal need to determine their shortfall and decide how much of it can be made up within a few years with acceptable risk. Even with an improved market this past year, goals and expectations might have to change: when to retire, whether to move, whether to keep working part time in retirement.
"It's a mistake to think that the only way to save for retirement or to catch up on savings for retirement is by investing," advises retirement columnist Ellen Hoffman, author of The Retirement Catch-Up Guide. "It's important for people to take a broad view of their entire personal financial situation."
That broad view encompasses three major categories of resources. There are your investments--stocks, bonds, and other market assets. There's your home, which usually goes untapped as a source of income. And there's your ability to work full or part time if necessary in order to repair the broken egg.
Your investments
Many retirees and soon-to-be retirees who lost significant sums in the market a few years ago itched to jump back in with both feet when the slide reversed. Bad mistake. "People have a tendency to do what got them into trouble in the past, even if it was painful," says Mark Gleason, a senior financial adviser with money managers Wescap Management Group in Burbank, Calif. But you don't want to turn gun-shy, either, loading up with bonds and other tortoiselike products. "When a market recovers, investors need to be fully invested at that point," says certified financial planner Phil Cook, whose firm, Cook & Associates in Torrance, Calif., has many retiree clients. "That's when you get your greatest appreciation."
So what to do? Pick a decent stock market return, says Gleason--the historical average is about 10 percent a year--and strive to achieve it, allowing for your own comfort level and avoiding past trouble spots. "Diversify, diversify, diversify" is a mantra not only overall but also within your stock basket, to raise returns and cut risk.
Scandal-scarred though they are, mutual funds remain the best way for most small investors to retain a diversified portfolio. Funds are rare that consistently outperform the market, have good growth potential and relatively low volatility, and welcome new investors with low initial minimums. One of Cook's choices is American Funds' Growth Fund of America, a conservative fund of large growth stocks with a minimum initial investment of only $250, and low operating expenses. Gleason, noting the possibility of further weakening of the dollar, suggests Morgan Stanley International SmallCap Fund, which invests in small foreign stocks and has a $1,000 minimum.
Index funds, which mimic the holdings of market indexes such as the Standard & Poor's 500 or the tech-heavy Nasdaq, can be bargains; they have low annual operating expenses. But most indexes are weighted by capitalization, so larger companies have disproportionate influence on price movement; that can make an index fund volatile at times.
Robert Bubnovich, a financial planner with Rio Financial Advisors in Irvine, Calif., likes the Vanguard Health Care fund for its high returns even during the latest bear market and a 15-year average annual return of 20 percent. (The minimum investment is $25,000, however.) Funds that invest in dividend-paying stocks can be a good bet for retirees and preretirees, as they provide growth, income, and benefit from recently lowered taxes on dividend income.
Many retirees burned by stocks have turned to bonds as a safe haven. But while bonds should be part of a retirement portfolio, financial experts caution against overemphasizing them, especially in a volatile market. In a climate of low interest rates and, consequently, low yields, locking up a chunk of your portfolio in long-term bonds like treasuries leaves you vulnerable to inflation--which some believe is already beginning to show its ugly face.
Intermediate bond funds are one way to limit risk. They fend off inflation with decent, if stodgy, returns. Bubnovich recommends the FPA New Income and Harbor Bond funds, both of which have 7 percent returns over five years. Check for fees on bond funds. The FPA fund, for example, imposes a 3.5 percent initial sales fee.
Your Home
A home has been one of the best-performing investments in the past decade for most people across the country. And for many, using the equity built up in a home is a way to help finance retirement. "This is an asset that can be used to fund your retirement, especially if you're behind," says Hoffman. The most straightforward strategy is to take out a home-equity loan or line of credit to use for living expenses or to invest in the market for rebuilding your portfolio. (But a line of credit can get you in trouble; it behaves like a credit card, and your house is on the line if you charge too much.)
Lesser-used strategies could offer more comfort. With housing markets still red hot in many parts of the country, you might sell a home that has built up considerable equity through appreciation and either move to a smaller, less expensive home that also costs less to maintain or relocate to a smaller, out-of-the-way city with less-expensive housing. Then bank or invest the returns.
This plan can shake loose hundreds of thousands of dollars and speed retirement, but it also involves lifestyle changes that may not be for everyone. Cook advises caution. "View this as your hole card; you don't want to use this card until you've used everything else," he says. "That's because once the equity is gone, that's it." If the new home is a rental, you'll also lose the tax deduction of a mortgage.
Reverse mortgages have become popular with some retirees. With such a loan against the equity in a home, you can receive the proceeds either as a lump sum or as a set amount each month. You must be at least 62. A reverse mortgage is best suited for those with considerable equity in a house and few other retirement assets--and who know they want to stay put.
Yourself
You have abilities, experience, and talents that make you a retirement asset. While not everyone wants to put off traveling or devoting time to a favorite hobby, working a few extra years could pump up your savings dramatically. William Arnone, a partner with Ernst & Young's Human Capital Practice, says delaying retirement makes sense. "More and more, this is becoming a very rational approach to the problem," he says. "What I'm hearing is people saying, 'The two years that I lost in the bear market are the two years I'm going to put off my retirement date.' It doesn't always work out 1 for 1, but for many people, it's a smart thing to do."
Arnone and other planners point out that you will also increase your Social Security benefits. "The vitality of being in the workforce will help keep you younger, too," says Cook. Many employers permit, even welcome, an offer to work a reduced number of hours a week or a month, even if you're getting pension checks from the same company. And with many businesses slow to add employees, they may welcome a valued worker back in a job-sharing or contract-work role. You might also be able to find part-time work with another company in your field or a related one. Do some homework to find out what needs the company might have, and make a specific proposal for part-time work that matches their needs with your skills.
You might click by charging an hourly consulting or project fee, especially for companies that have seasonal or contract-specific employment needs, such as defense firms. A detailed proposal, based on your knowledge of the firm's needs and done in the style and format required, is necessary. Cook notes that both public- and private-sector employers are increasingly outsourcing work to keep payrolls flat. In negotiating, you might remind the firm that hiring you for a set period saves the trouble of hiring a new employee--who may need to be laid off when the work ends.
If you enjoy writing or photography and have clips or a portfolio, query small book and magazine publishers and local newspapers. Turn a green thumb into financial green by selling the plants and flowers from your garden, perhaps getting into landscape planning. Hire yourself out as a baby sitter for bed-and-breakfast inns--a pursuit becoming especially popular with retirees. Whatever you do, make it something you enjoy.
This story appears in the June 14, 2004 print edition of U.S. News & World Report.