The day has come. You attend the retirement party. They hand you the golden cufflinks or the gold watch, stuff you full of hors d’oeuvres, and send riding you off into the sunset. From now on, you’re going to sit on the porch, drink lemonade, and watch the world go by.
It’s an idyllic lifestyle until you start to have one of those nagging concerns that almost every retiree probably has a few thousand times—sometimes in the course of one day: “Do I actually have enough to last without running out of money?”
The quick and dirty answer that most financial planners give you is that you need to have your assets allocated based on a formula of 110 minus your age. So, if you’re 70, then you want to have 40 percent in equities and 60 percent in fixed income.
However, a quick check of your investment accounts isn’t going to truly answer the question of whether or not you have the appropriate mix of assets. Understanding the asset allocation picture isn’t as simple as looking at your account statements and doing quick math.
Here are three mistakes many retirees or near-retirees make when determining their true actual asset allocation picture:
- You’re including your house in your assets. I often hear people describe their net worth in a conversation like this: “I have a $200,000 house and $800,000 in investments, so I have a net worth of a million dollars.” The problem with this description is that your house cannot independently generate income except in a reverse mortgage, which has its own twists. Basically, owning a home free and clear eliminates the need for you to have a housing expense—save, of course, for property taxes, insurance, and home maintenance costs. If you were to sell your house, then you’d need to use the money that you generated to create a stream of income to pay for your subsequent living arrangements, whether that means buying another house, renting one, or moving into an assisted living facility.
- You don’t include Social Security and pension payments as part of your fixed income. Let’s say that you receive a Social Security payment of $2,000 per month and a pension of $3,000 per month. That’s $5,000 in reliable monthly income--just like the sort you expect from the fixed income portion of your portfolio. To properly figure how to include that money in your fixed-income allocation, calculate how much it would costs to buy an annuity that would pay out that same $5,000 each month. The cost is roughly $1 million. (Remember: This amount needs to be adjusted for inflation in the case of Social Security, and possibly for your pension payment as well.) That “fictional” annuity amount should make up a big chunk of your fixed-income exposure. In fact, if you have a total portfolio worth $2 million, you’d need just $200,000 in bonds or other fixed income securities on top of fictional $1 million to get your fixed-income allocation to 60 percent of your total portfolio. Be sure to include it, otherwise you might have too much invested in bonds or similar investments.
- You confuse pre-tax and after-tax assets. A tip of the hat goes to Bob Veres at Advisor Perspectives for this example: Let’s say that you have $500,000 in a Roth IRA and $500,000 in a traditional IRA. You’ve already paid taxes on the Roth IRA; however, the traditional IRA is tax-deferred. When you withdraw taxes from the traditional IRA, then you’ll have to pay income taxes on your withdrawals. If your effective tax rate is 20 percent, that means that for every $100 you withdraw from the traditional IRA, you’ll only wind up with $80 in your pocket after, so the effective value of your traditional IRA, when compared to the Roth IRA, is $400,000.
So, whether you’re already sitting on the porch watching the world go by, or you’re just dreaming of the day, it’s important that you have a full picture of what you have and what it will take to make those days ones of idyllic bliss rather time spent worrying over your next meal.
Jason Hull is a candidate for the CFP(R) Board’s certification, is a Series 65 securities license holder, and owns Hull Financial Planning.