by Ryan W. Smith
There are three factors that typically determine successful retirement planning: saving, education and investing. Which is more important? Are they of equal value, perhaps? For periods of time during the accumulation period of one’s working years, the past six years for example, investing will definitely appear to be the most important factor. With most major indices up over 50% from their 2008 lows, it would appear that investing would be the driving factor behind retirement account appreciation.
But what happens during a bear market? Or during a period, such as the last 18-24 months, where the major markets meander in a range? These situations are much more common than those when a market heads straight north. It is during these periods where saving and education tend to be paramount.
Over the life of a retirement portfolio, from the accumulation period during working years to the distribution period during retirement, the biggest long-term factor regarding successful retirement planning is saving, according to most analysts. This is primarily because savings are the only aspect of retirement planning that a client has control over.
Savings is also an area where investors make significant mistakes. Many people have had sudden expenses arise, a medical bill, a car or home repair or some other costly expenditure where their regular savings couldn’t cover the total expense. Perhaps they couldn’t contribute to an IRA for that month, quarter or maybe even that year. Perhaps they needed to suspend 401(k) contributions to make up the difference.
The particulars are as varied as the situations, but essentially a regular retirement savings method was stopped or suspended because of a one-time expense. In many cases, individuals will fail, forget or delay restarting their retirement savings. This will have a long-term impact on overall retirement savings, both for the missing principal, but also for the never-earned interest on that principal.
Education, lack thereof or refusal to seek the knowledge, is also an area of retirement planning ripe for mistakes. Like savings, it is one of the few areas in retirement investing where clients have any amount of control. No amount of knowledge will avoid poor performance in perpetuity, even the savviest investors have downturns, but a willingness to learn is essential to successful long-term investing.
Many in the industry have said that the most difficult clients are those who think they are properly and fully educated regarding finance and investing or have been highly educated in other fields and believe they can “just figure out” what is needed. These clients, many advisors feel, overvalue their expertise and can have a much higher reliance on portfolio returns, rather than regular saving methods, often leading to much greater losses when market forces work against their investments.
Similarly, an over-reliance on portfolio returns has left many retirees wondering what might have been during market downturns. Performance, even with aggressive portfolio allocation, is never guaranteed. In a rising market, an aggressive allocation can lead to out-sized returns, which is wonderful. However, these returns can also lead to complacency and a failure to recognize when market conditions change. Markets, after all, tend to rise slowly over time and portfolios that are not readjusted to reflect current conditions are vulnerable to larger losses when the markets shift. It is a staircase up and an elevator down, as the saying goes.
Conversely, a solid savings plan over a long period of time has been shown, in study after study, to be the best predictor of retirement portfolio success. The key then becomes risk tolerance, with a lower savings rate necessitating a riskier portfolio. For a time, riskier positions might just pay off, as many have experienced these past 6-7 years. However, with a higher savings rate, a more aggressive allocation is not necessary.
Several studies have shown that the combination of a 4% savings rate and an aggressive 80-20 split between stocks and bonds can, in many instances, lead to a bigger nest egg than a 6% savings rate and a 50-50 split. However, many clients simply do not have the risk tolerance to ride that wave for 30 years. What nearly every study has shown, conversely, is that increasing savings will lead to a larger retirement portfolio over time.
Successful retirement planning is contingent on three factors primarily: savings, education and investing. Risk tolerance is one of the main keys needed to determine investment strategy, but every investment strategy will perform terribly if it is not looked after and updated regularly. Those updates, along with strategies for dealing with market changes, require a willingness to be educated and to learn about investing and finance. However, typically the most important factor in determining successful retirement planning is to save as money as possible for as long as possible. For the vast majority of clients, this is the factor most often within their control.