A website I like to keep an eye on is FundAdvice.com published by Merriman Inc - a registered investment adviser in the USA. Paul Merriman is the founder of the firm and regularly comments on investing including his regular Sound Investing radio program.
This week I came across an article written by Merriman back in 2003 which still has some valuable lessons for those planning for retirement. Even though it is US based and does not talk about the nuances of the Australian superannuation and pension system, the general pronciples are really useful. So here is an abridged version of the 10 steps Merriman sets out:
Step 1: Determine what investment return you need
Figure out your essential living costs per month - the amount below which you simply cannot make it. Your definition of this will be uniquely your own.
This first step can be discouraging. But it's essential because it will force you to face up to reality - ideally while you still have options available to you.
Step 2: Determine the investment return that you desire
Your goal is to arrive at a figure that, if you added it to your base monthly income, would make your life much better, giving you a future worth looking forward to.
A good rule of thumb is that you can conservatively count on withdrawing 5 percent of your portfolio every year. If you invest that portfolio well, you can keep doing that with a high probability that your portfolio's value - and thus your annual "draw" - will gradually rise over time without much risk of running out of money.
The flip side of that rule of thumb is that you can know you have enough to retire if your investments are worth 20 times the annual income you desire from those investments.
Step 3: Determine your tolerance for risk
Figure out how much you are willing to lose and invest accordingly.
Most retirees invest in stock funds and bond funds. And for most of them, the basic way to control risk is by increasing or decreasing the percentage allocated toward bonds. More bonds means lower risks (and generally lower returns as well). More stock funds means higher risks (and generally higher returns).
These first three steps are the most important ones in our 10-point plan. But even when you have completed them to the best of your ability, you are far from finished if you want to maximize your ability to enjoy your retirement.
Step 4: Base your decisions on what's probable, not what's possible
In planning your retirement, you'll always be better off to use conservative assumptions rather than optimistic ones.
Step 5: Determine what assets have the highest probability of giving you the returns you need
If you diversify among asset classes that have performed well over very long periods, you won't get snookered into putting all your trust in whatever has been performing well lately.
Step 6: Determine what combination of assets will produce the return you need within your risk tolerance
You may want the expected returns that come with an all-equity portfolio. But such a mix of assets is too risky for most retired people. Remember the general rule that the higher the return you seek, the more risk goes with it.
There are three steps in this process.
First, find the best combination of equity assets.
Second , identify the best fixed-income assets to stabilize your portfolio.
Third, find the right percentage combination of equity assets and fixed-income assets to give you the best balance of return and risk.
Merriman's advice: Give priority to the risk measurements, not past returns.
Step 7: Keep your expenses as low as possible
There are two kinds of expenses: ongoing and one-time-only. Almost all investments involve some type of recurring expenses. Savvy investors always want to know what the expense ratio is. Naïve investors ignore this, focusing instead on marketing hype and recent returns.
Expenses in actively managed funds, which depend on stock-picking, vary widely, though they are almost always higher than in index funds.
Here's a little formula that Wall Street doesn't want you to know: Higher expenses mean either less return or more risk. This is true in general for almost every investment you can make. If you pay higher expenses, you will either get lower expected returns or take more risk - and often it's both.
Step 8: Minimize your taxes
The comments made here by Merriman were more relevant to the US situation. In Australia it is about determining the best structure for your financial investments - e.g. super, pension, discretionary trust, directly held and in who's name should each asset be held. Part of this discussion needs to way up the tax implications including the tax status of the particular structure and the implication of applicable tax offsets such as the Senior Australian Tax Offset (SATO).
Step 9: Put the management of your portfolio on automatic
This is the best way to keep your emotions from subverting your intentions and your plans.
Economists who study human behavior say people make financial decisions based on their emotions. Yet the outcomes of those decisions are not determined by emotions. The outcomes are determined by hard, cold reality. I believe this difference is one of the biggest challenges facing investors.
If you're still accumulating money, sign up for automatic investment plans whenever you can. That way, you'll know the money goes to work for you when it should. Dollar-cost-averaging will make sure you automatically buy more shares when prices are lower and fewer shares when prices are higher.
Index funds will make sure you automatically diversify and adjust your portfolio for the comings and goings of various companies.
If you are using a timing system, hire somebody to do it for you. That way you know for sure that the timing system you have chosen will be followed.
Putting your portfolio on automatic is also the way to give yourself the highest probability of success and to defend yourself against sales pitches from brokers who want you to do something different.
Step 10: Determine the best strategy for withdrawing your money
This can be tricky, and you may benefit from sitting down with a professional to make sure you understand the decisions you must make and their ramifications.
One of the most important decisions you face is whether to take out a fixed amount from your investments every year or whether to let your withdrawal vary from year to year depending on the performance of your investments.
This is essentially a choice of what type of risk you want to take. If you take a fixed amount from your portfolio, you will know what you can count on and plan your life accordingly. But you take the risk that you could run out of money because your withdrawals won't have anything to do with your investment performance.
If on the other hand you take a variable amount, say 5 percent or 6 percent of the portfolio value each year, you can be pretty sure you won't ever run out of money, and you'll most likely have some left over to leave in your will. Consequently, you'll know that the amount you withdraw is an amount you can afford. On the other hand, with this plan you won't know what you can count on for living expenses in the future.
You also must figure out a way to make withdrawals that will keep your portfolio properly balanced in the assets that in turn will keep you within your risk tolerance.
If you would like to read the full article please take a look at - A perfect retirement in 10 easy steps
A further step which Merriman has not included but is relevant for Australians contemplating retirement is to factor in the possibility of accessing the Age Pension or Commonwealth Seniors Health Card and the benefits that come with this access.
In conclusion, planning for retirement is not an easy task but there are some important steps that can be taken to help provide a little more confidence that you are well positioned financially to make the most of this stage of your life.
If you would like to make an appointment to sit down to discuss any of these issues or have a chat over the phone or via email please do not hesitate to get in contact.