Senior Investment Analyst of Vanguard's Investment Strategy Group
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I’ve been paving my path toretirement since I held my first job selling beach tags in Sea Isle City, NewJersey. I wasn’t thinking about retirement at age 15 per se, but I did depositthe money I earned in a savings account.
Fast forward to today. I’m abit farther along on my path to retirement, but 1 thing hasn’t changed—I’mstill laying the groundwork for the future. And my ultimate investment goalisn’t just being able to retire. It’s having financialsecurity in retirement.
Generally speaking,financial security is peace of mind that comes from having confidence you canattain all of your financial goals both now and in the future. To me, it meansbeing able to educate my daughters, travel abroad, own a second home, and leavea modest legacy.
Prepare for the road ahead
Retirement isn’t a 1-stopdestination—it’s a phase of life that may span 20 years or more. Thepriorities, challenges, and resources you have at the outset of your journeymay change over time, so be prepared to follow a winding path.
There’s no universal routeto financial security in retirement, but there are common steps in the journey.The direction you take at each juncture will determine the path you’ll follow.
- Determine goals. Identify and prioritize the things you want to accomplish.
- Understand risks. Be aware of potential risks that could get in your way.
- Assess financial resources. Take inventory of your present and anticipated future assets. Most of us will rely on several financial resources in retirement. Different resources can meet different needs.
- Develop a plan. Create a long-term strategy that takes your highest-priority goals, biggest risk factors, and available resources into consideration.
The Key Elements of Retirement Planning
Here’s a closer look at theimportant things you should consider when mapping out your plan.
Retirement isn’t a singlegoal. It’s a combination of multiple goals that vary in importance. Generally,you’ll want to allocate your assets toward your goals in order of priority,using reliable, easily accessible resources to achieve your highest-prioritygoals.
Let’s say you have 4 maingoals, which you’ve prioritized in this order:
- Living expenses (food, clothing, housing, recurring health care expenses, etc.).
- Contingency reserve (home repairs, unanticipated health care expenses, etc.).
- Discretionary spending (vacations, eating out, entertainment, etc.).
- Legacy (transferrable wealth).
Retirees face several risks,which can be grouped into 5 categories:
- Market and investment risk: The risk your portfolio will lose purchasing power due to market variables, including investment returns, inflation, and interest rates. Your lower-priority goals (such as discretionary spending or legacy) may be able to withstand greater levels of market and investment risk.
- Health risk: This risk is twofold. It’s the risk you’ll need care because your health is declining plus the risk you won’t be able to afford care. You can determine your health risk by evaluating 3 factors: your overall health, available coverage, and desired level of care.
- Longevity and mortality risk: Longevity risk is the risk you’ll live longer than expected and potentially outlive your savings. Mortality risk is the opposite—it’s the risk that you’ll live shorter than expected, potentially widowing a spouse or leaving behind more wealth than anticipated. The average life expectancy around the world is increasing, but your own life expectancy is influenced by several factors, including gender, lifestyle, and genetics.
- Event risk: The risk you’ll face an unexpected event with a large financial impact, such as an unplanned family expense or an extensive home repair or relocation. Roughly 72% of current retirees report having experienced at least 1 such “shock” in retirement, according to the 2015 Risks and Process of Retirement Survey from the Society of Actuaries.
- Tax and policy risk: The risk that rules about public health coverage, retirement benefits and pensions, and taxation of retirement benefits and estates will change. This risk can be lessened by controlling your asset allocation, asset location, and spending plan.
Your retirement resourcesinclude more than your portfolio. We categorize the resources you may have inretirement into 3 groups:
- Guaranteed income (Social Security, pensions, annuities).
- Liquid assets (investment accounts that you control).
- Other resources (insurance policies, employment income, property).
Basic living expenses
Consider using guaranteedincome to cover your basic living expenses. Guaranteed income, such as SocialSecurity benefits, annuities, and income from pensions, provides effectiveprotection from market and investment risk as well as longevity and mortalityrisk. This makes it your most dependable source of income.
If guaranteed income doesn’tcover all of your basic living expenses, employment income can be used becauseit also offers protection from market and investment risk.
Consider using liquid assetsto cover these expenses. Liquid assets include investments in anemployer-sponsored retirement plan or savings in a taxable account.
Your asset allocation shouldalign with your risk tolerance and the time horizon of the goals you want tosupport. If your investment portfolio needs to support multiple goals withdifferent capacities for risk, your asset allocation should reflect a blend ofobjectives.
Liquid assets provideeffective protection against tax and policy risk because they can adjust tochanging regulatory and tax environments. Additionally, insurance and employmentincome or property income can be used to cover these expenses.
Because this type ofspending is lower on your list of priorities, you may be able to toleratehigher degrees of uncertainty. Liquid assets or employment income may be themost adaptable resources to meet this objective. Any guaranteed income thatexceeds your daily living expenses can also be used to meet this goal.
This long-termgoal requires a surplus of assets that can be passed on toheirs or support charitable objectives. Leaving property or liquid assets thatare appropriately invested can maximize the value of your bequest. Lifeinsurance can also be used as long as the benefits outweigh the costs.
Forge your path
Achieving financial securityin retirement may be a universal goal, but the strategy that’s right for youdepends on your own circumstances—your goals (and how you prioritize them), thepotential risks you face, and the resources you have.
Retirement is complex. Youmay have competing objectives that require you to make difficult choices. Butthe good news is, you have options. You can identify your priorities and alignyour financial resources to pursue your goals and mitigate risk. See Vanguard’s roadmap to financialsecurity: A framework for decision-making in retirement formore information. Or you can work with a financialadvisor so you don’t have to figure it all out for yourself.
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