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 For Retirement Planning, Save—and Invest—Aggressively by Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc. January 3, 2007 Dear Carrie, I am 45 years old and have about $70,000 in retirement money that is currently in CDs. What is the best way to invest it, given my age and that I do not foresee needing to liquidate this asset until retirement (hopefully after my 70th birthday)? —A Reader Dear Reader, Your question raises a lot of fundamental issues about retirement, about risk and about investing. And although I can’t give you specific advice, I can say that in order to achieve a secure retirement, you're probably going to need to save—and invest—a lot more aggressively. Here’s why: Estimating future needs To explain, let's start at the finish line. Assume that you've just turned 65 and retired (I realize you're willing to work until you're 70, but let's be on the conservative side). How much money are you going to need to be confident that you'll have an income for the rest of your life? You don't mention your current income, but let's assume you're going to need an income of $50,000 a year. You might get $15,000 from Social Security, but for the sake of discussion I'll assume that there's no other pension and no other sources of income. That means (at least in our hypothetical case) you'd need to come up with $35,000 per year for another 30 years (again, that may be overly conservative—but you want to live a long time, right?). How much money does that take? The Schwab Center for Financial Research suggests that you'll need a portfolio 25 times as large as your first year withdrawal in order to have a reasonable degree of confidence that you can maintain your standard of living, adjusted for inflation, for 30 years. In your case, that's $35,000 x 25 or $875,000. Now $875,000 is a pretty daunting sum. Can you get there with the $70,000 you've got now? Let’s say you buy a five-year certificate of deposit (CD) with an annual percentage yield (APY) of 4.75%. If you could maintain that rate of return over the next 20 years, your $70,000 will grow to just under $180,000. Let's say we ramp it up a bit, and you could earn 8% a year on your capital. That would give you a bit more than $325,000 in your account when you turn 65—a lot more than $180,000, but still less than half of the $875,000 you're likely to need in our hypothetical situation. (In fact, you'd have to earn an average of 13.46% a year to reach your goal at the age of 65, which is not a realistic expectation). Obviously, your situation may be different, even radically so. You may have a pension or receive an inheritance; you may have other assets besides your retirement savings and you may work until the age of 70 or beyond. The point is that it's useful to have a reasonable idea about what you're going to need, then start working toward getting there. I'm reading between the lines, but it sounds as if there could be a pretty big gap between where you are today and where you want to be when you retire. Save more money How will you fill that gap? The first way is obvious: save more money. Consider contributing the maximum to your 401(k) plan ($15,500 for 2007 and 2008) and/or your IRA ($4,000 for 2007 and $5,000 for 2008). (If you think you might be in the same or higher tax bracket when you eventually take money out, consider a Roth IRA or Roth 401(k), if available at work. There's no immediate tax deduction, but qualified withdrawals after the age of 59 ½ are tax free. Check with a tax specialist or your financial services provider to see if you're eligible, which is determined by your income level.) When you turn 50, you can invest even more in your tax-advantaged retirement plans using the catch-up provision (currently up to an additional $5,000 annually for 401(k) plans; up to $1,000 a year for IRAs and Roth IRAs). Then, if you are still able to save more, open a taxable investment account and start adding to it. Looking again at our example, if you contribute an additional $12,000 per year for the next 20 years, and you manage to earn an average of 8% per year, you could reach the hypothetical goal of $875,000. Of course, the more you save, the greater the likelihood of meeting your goal. As I mentioned above, you can also narrow the gap between what you have and what you'll need by working longer, which is great on many levels (not the least of which is that, by postponing receipt of your Social Security benefit, you'll qualify for a higher monthly benefit). But it's not always possible. It can be hard to find a job later in life, and of course you can't really predict that you'll be healthy and able to work as you get older. Invest for growth And finally, you'll add to your retirement coffers by investing for growth. Certificates of deposit and other fixed-income investments are generally safe, reliable sources of income, not growth. Capital growth generally means equity exposure. Yes, stocks and stock funds are riskier (more volatile) than CDs. But by investing only in CDs, you may be incurring a much more insidious risk: the risk that inflation will erode your purchasing power. A dollar in 20 years will buy a lot less than a dollar today. Historically, stocks have outperformed other types of investments, and their potential for growth has made them an important component of long-term portfolios. And while past performance is not a guarantee of future results, with 20 years to go until you reach the traditional retirement age, you should definitely consider adding equity exposure to your retirement portfolio. One possibility would be to invest in a target fund. As the name suggests, these funds "target" a particular timeframe, usually in five- or ten-year increments, and invest in a mix of stocks, bonds, and cash that automatically adjusts as the target approaches. In your case, you'd pick a fund designed for investors retiring in 2030 to 2035. The fund would be relatively aggressive now, but as the years went by, it would adjust to become more conservative. Target funds are typically highly diversified, which also tends to reduce your risk. So while I can't give you a specific answer about what to do with your $70,000, I hope I've convinced you to think about (a) saving more, and (b) investing with growth in mind. You may also be well served by finding a financial advisor who can help you make more fact-based estimates of your future needs and help you create and execute a strategy that makes sense for you. Good luck! Important Disclosures Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. Investment value will fluctuate, and shares, when redeemed, may be worth more or less than original cost. Certificates of deposit offer a fixed rate of return and are FDIC-insured up to $100,000 per institution. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve. Past results are not indicative of future performance. Diversification strategies do not assure a profit and do not protect against losses in declining markets. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction and investment strategy for his or her own particular situation. (1207-7097) Return to Top |
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