(PUB) Investing 2016

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Being Too Conservative Is a Big Risk for Retirees Portfolio Matters | Christine Benz

Management. “While this isn’t a risk in a traditional sense, it means you haven’t best utilized your money to fund retirement and consumption.” Here are some of the key ways that retirement-savers and accumulators run the risk of being overly conser- vative in their retirement assumptions; these items are common inputs in retirement savings calculators and software programs. 1 | Assuming Social Security won’t be there “I do not incorporate Social Security benefits into my retirement forecasts and future cash flow models. The reason being is because we all know how irrespon- sible Washington has been with the Social Security fund. Plain and simple.” So commented a reader on a recent Morningstar.com article about what sort of assumptions younger investors should make about their future Social Security benefits. Considering that the Social Security Trust Fund is pro- jected to run dry in 2034 , maintaining conservative assumptions about Social Security benefits may seem like an extremely prudent tack. But assuming that retirees 40 years hence will get zip, nothing, nada from Social Security is a pretty big stretch, given that some fairly simple, albeit controversial, fixes—such as means-testing, extending the full retirement age, or raising the cap on income that’s subject to Social Security tax—can put the program on firmer footing. And even if a young accumulator is convinced he or she won’t get anything from Social Security, that assumption necessitates a heroic bump-up in saving relative to the accumulator who assumes she’ll get something. Using the Ballpark Estimate calculator and assuming no help from Social Security, a 25 -year-old earning $40 , 000 a year and receiving a 3% annual pay increase would need to save nearly 25% of her annual income from now until retirement age to help supply in-retirement cash flows equivalent to 80% of her final year’s working income. That’s a heavy lift, especially for individuals with more modest salaries who must steer a healthy portion of their paychecks to necessi- ties. By contrast, the accumulator who assumes the status quo for Social Security benefits would need to save 6% of her income annually to achieve the same

When it comes to retirement planning, “hope for the best, plan for the worst” is a reasonable motto. Given that many retirees fear running out of money more than they fear death, it’s only prudent for them to manage their retirement plans with a healthy appreciation for all that could go wrong. However, I think there’s a risk—albeit an underdis- cussed one—that well-meaning retirees and retire- ment-savers can take caution too far. For example, I’ve run into 75 -year-old retirees who, in the interest of playing it safe, are spending just 2% of their portfolios annually; at that pace, they’re very likely to leave a very large kitty behind. That may be what they want, but it may not be. In a similar vein, I’ve met 40 -year- old accumulators who tell me that they’re certain Social Security won’t be there for them, or that they’re assuming their portfolios will return just 2% in their 25 -year runway to retirement. Of course, I realize that it seems ridiculous to discuss being too conservative about retirement planning in an era in which the median 401 (k) balance, per Vanguard’s How America Saves report, was just shy of $30 , 000 in 2015 . But there’s also a segment of the population that could be playing it too safe with their retirement-planning assumptions, and those too- conservative assumptions carry costs. Accumulators who are too conservative in their retirement-planning assumptions might short-shrift other pre-retirement goals because they’re trying to swing a gargantuan savings rate, while overly parsimonious retirees might fail to enjoy the fruits of their labors or simply worry about running out of money more than they need to. “One risk everyone talks about is failing—going broke when you’re older—but another risk that’s rarely talked about is the risk of having some big pot of money when you die,” said David Blanchett, head of retirement research for Morningstar Investment