Coming to Grips with Retirement Realities

April 14, 2008

What‘s that tornado-like roar of rushing air? It’s the sound of 76 million baby boomers taking in a deep breath as we reach the next milestone of a massive demographic movement through the American landscape. Every 10 seconds for the next 15 years, another member of this generation will reach age 60.

Retirement is now just around the corner for a large segment of the population. Easy Rider star Dennis Hopper is featured in commercials promising that the Boomer’s retirement dreams will be like no other. He also notes that the Boomer retirement will not be anything like the Boomer’s parent’s retirement. What will your retirement look like? Are you ready?

Assessing your preparedness for retirement really boils down to one question: Will you outlive your money or will your money outlive you? Forget about the fantasies. Let’s not count on winning the lottery, investing in a 20% annual investment return, or an unexpected inheritance that will bail out your retirement fund. Hopefully you have sat down with a good financial professional and structured a savings and investment plan that makes sense for you, your family and your medical practice. If not, now would be the time to get started.

Your planning for retirement must focus on the three things you can control:

Step #1: How Much You Spend

How much income do you think you will need in retirement? Some people say 70% of pre-retirement income. That number is a myth. To paraphrase an old campaign slogan, it is not your income but “YOUR EXPENSES, STUPID!” That’s right—what you earn has no direct relation to what you need to have in retirement. The amount you need in retirement is totally and absolutely based on your expenses.

Retirement is a journey, and like any journey, you can’t begin if you don’t know where you are starting from. The first step is to sit down and analyze your expenses and set up a reasonable budget.

Step #2: How Much You Save

We are not a nation of savers: in the years of 2005 and 2006 we had a negative savings rate as a nation. When I speak to corporations and their employees I find that many are participating in their company’s pension plan these days, mostly a 401(k) plan. That’s good, but all too often I find that most employees are only contributing enough to get their full company match.

As a physician, and especially if you are self-employed, you have more flexibility than many other small businesses. You can control the type of pension that you have and if you are employing many part-time employees as many practices do, you can customize your retirement plan more than most. However, even though with the right plan you can shelter upwards of 50% of your net income from self-employment (in a later blog I will summarize each type of pension plan), I find that many doctors are simply not saving enough. The alternative is deferring retirement but do you want to be practicing medicine into your 80s?

Step #3: When You Retire

The last step covers investing. Let’s bust another myth. One frequently repeated piece of advice is the rule of 100—subtract your age from 100 and that is how much you should have in equity style investments. If you go by this rule, at age 60, 40% of your money would be in equity-style investments and 60% in bonds, CDs etc. Unfortunately that no longer works. We are living longer and half of you reading this may will live to see your 100th birthday. Therefore you must design your investments to meet the needs of a 30-year retirement. Retirement investments must get the highest return that’s possible, within a comfort zone that will let you sleep at night.

The minimum equity exposure for most of your investment plan needs to be at or around 70% until you are sure that you have enough money saved (ie, pension, IRA, savings) to reach retirement goals by withdrawing less than 5% each year from your total investments.

Does this much equity exposure feel like too much risk? Unfortunately, there is no such thing as a risk-free investment. If you invest to protect your principle above all else, you will be eaten up by inflation. Consider the real rate of return, which is the return on your investment minus the rate of inflation. If a T-bill is paying 4% and inflation is 3.5%, then you have only increased your purchasing power by 0.5%; at that rate you will never be able to afford to retire.

If you’ve followed these steps, you have gotten your budget in order and you are preparing to maximize pension contributions and savings. Hopefully you are starting to reevaluate your investment mix. Congratulations! These are the first steps to gain control of the next part of the rest of your life. Your retirement is in your hands.