Estimate Needs, Prepare for Retirement (Elaine Longer Commentary)

Accumulating enough wealth to fund a comfortable retirement requires a long-term plan. This plan will involve two major activities — (1) estimating your desired income at the time of retirement, and (2) working to “close the gap” between this amount and the amount your assets could realistically produce today. You have between now and retirement to accomplish this.

1. Projecting income. Most retirees have four basic sources of income — Social Security, company pension or retirement plans, personal savings, and supplemental income from part-time work or other retirement activities.

Consult your local Social Security office and company benefits administrator to estimate future income from these sources. Many experts say that Social Security and pension income will account for only 50 percent of the average retiree’s income. The balance typically comes from savings and investment.

How much will you need to accumulate? First assume that you don’t change your practices between now and retirement. How much more will you save at your current savings rate? How much will your savings and investments grow in value? What will your house be worth? What other assets will be available at retirement, and how can they be repositioned or converted into income producing investments? Assume a realistic growth rate. The difference between your future income and estimated expenses should become your accumulation goal and major priority for your remaining years of work.

2. Closing the gap. First consider tax-advantaged investing. Maximize your retirement plan contributions at work. If self-employed, take advantage of SEP, Keogh or IRA plans. Tax-deferred compounding raises your real rate of return and helps close the gap much faster.

Your plan will also require a commitment of after-tax income as well. Don’t overlook investment strategies that have a goal of tax-deferral. In most cases, compounded growth and tax-free bond interest income are preferable to paying annual taxes on earnings.

Aside from taxes, strive to understand other key issues influencing performance of your personal retirement portfolio. These are:

• Time —Time plays an essential role in wealth accumulation. The more time you have, the less money you must commit to the task. Quantify your accumulation goals in terms of the amount you must invest and the time remaining to do so. Break down by year and month the amount you must save.

• Risk and return expectations — Asset groups perform more predictably over long periods of time. By allocating your investments to reflect historical growth rates among various asset classes, you can reduce the total volatility of your portfolio. Avoid having to push your investing beyond a comfortable risk level.

• Inflation — Inflation can begin robbing your retirement of purchasing power even while you are working and saving. And after retirement, your assets must continue appreciating to counteract a continual loss of real (inflation-adjusted) wealth.

Income planning poses a different set of challenges for the young and older investor. For example, the earlier you start investing for retirement, the less money you must set aside to meet your goal. Time, not the amount invested, is the secret to effective wealth accumulation. If you have 40 years before retirement, you would need to set aside only $500 a year to accumulate each $100,000 upon retirement. Compare this to $7,240 per year for someone with only 10 years before retirement (assuming a 7 percent compounded rate of return). If you are nearing retirement and feel unprepared, you must make good use of the income producing time that remains — but without taking undue risk. A younger or middle-age investor can rejoice in the luxury of time but must take advantage of it prudently.

Planning for retirement is an intellectual and practical exercise. Saving is a lifestyle choice. Your decision to accumulate more will force hard choices upon you and your family. But attaining a level of financial security and a retirement that is well-planned will prove to be worth the effort.

Elaine Longer, CFA, is President of Longer Investments Inc., an investment advisory company in Fayetteville registered with the SEC. For more information, visit www.longerinv.com.