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Inevitably retirement planning discussions with my clients include listening to stories about their parents and grandparents. Frequently, clients like to reminisce about how their family members from previous generations handled their money. For some investors, these personal experiences serve as the benchmark for how they will plan their own financial future. Unfortunately, the information to which clients get anchored may be totally irrelevant to their own financial situation. This may lead to poor financial decisions that can adversely impact one’s ability to achieve their retirement goals.
The concept of anchoring is a behavioral bias where psychological benchmarks may carry a disproportionately high weight in one’s decision-making process. In the stock market, someone with an anchoring bias may hold a security that lost value because they have anchored their fair value estimate to their original purchase price rather than company fundamentals. The same concept applies to folks who anchor their retirement planning strategy to those of previous generations despite today’s vastly different landscape.
Below is a list of items that have evolved over the years which must be taken into consideration when planning for retirement in 2021.
1) Lifespan: Life expectancy has significantly increased over time. In 1950, the average lifespan in the U.S. was merely 68 years. By 2015, that number had jumped over 15% to 79 years. Medical advancements and an increasingly health conscious society has made living to 90 a common occurrence.
Planning for retirement in decades past, with shorter life expectancy, was much simpler. Collecting social security and pensions immediately was enough of a plan for someone retiring in their early 60s, as they likely would only live for a few years of retirement. In today’s world, retirees need to develop a strategy whereby their assets support them for a 20 to 30-year long retirement. In addition to the sheer length of time, the challenge is compounded when considering the astronomical costs associated with long-term care needs. It is estimated that 70% of Americans over the age of 65 will need long-term care services during their lifetime. As people continue to live longer, over the next 20 years this will comprise roughly 20% of the U.S. population.
Retirees of today must consider a variety of solutions to plan for the blessing and challenge of a longer life. Some successful strategies may include working longer, delaying social security, and buying long-term care insurance.
2) Employment: Gone are the days when a person planned on spending his entire career with one employer. Today, the median amount of time an employee has been with their current employer is 4.1 years. A contributing factor to the trend of jumping from company to company is the transition away from defined benefit plans, like pensions, to defined contributions plans, like 401(k)s.
Pensions bred and rewarded loyalty, with the onus of retirement savings on the employer. 401(k)s, on the other hand, facilitate more freedom in career trajectory. An individual can spend a few years at a company, develop skills and experience, then jump to a new organization while bringing along their retirement nest egg from the previous employer. However, it also shifts the retirement savings burden to the employee. It’s now the employee’s responsibility to ensure they are saving enough, investing prudently, and are sufficiently organized to meet their retirement goals. Failure to take on these responsibilities will leave the retiree in a precarious situation.
3) Interest Rates: In 1970 the average yield on the 10-year Treasury was 7.35%. It stayed in that range, or higher, for the subsequent 25 years. By comparison, last year the average was below 1%. Historically low interest rates have shifted the way retirees need to manage their capital. The days of laddering a AAA municipal bond portfolio and living on a 5% tax free coupon are a distant memory.
For retirees to achieve their financial goals, their investments will likely need exposure beyond just fixed income. Additional stock exposure may be necessary for assets to last for a multi-decade retirement. Furthermore, other financial products may be needed to meet a client’s cash flow needs. These may include annuities, reverse mortgages, and alternative assets classes, depending on the client’s personal situation. This type of creativity is now a necessity in funding one’s retirement.
4) Housing: The average American home size nearly tripled from 983 square feet in 1950 to 2,657 square feet as of 2014. As one ages, it becomes more difficult to navigate or maintain a large home. Going up and down the stairs or even walking from one part to another in a large home can be challenging. The psychological burden of taking care of a large home can also be draining. In decades past, aging in place may have been a fine option. Today, since many Americans are living larger, downsizing to a smaller home, retirement community, or apartment building should be a real retirement consideration for many.
5) Kids may need more help: As of 2019, nearly 40% of U.S. citizens earned a bachelor’s degree or higher. That compares to approximately 3% in 1950. While it’s great to see our country prioritizing education, its ever-increasing cost means today’s youth are starting adult life with a mountain of debt. The cost of college has grown exponentially over the years. In 1971, tuition, fees, room and board cost $18,140 and $8,730 for private and in-state public colleges, respectively, both in today’s dollars. In 2018, those numbers were $48,510 and $21,370, respectively.
Frequently, the burden of continuing to support kids as they enter adulthood falls on parents. That timeframe has expanded as the increasing number of students pursuing higher education means many are taking longer to get a full-time job and become self-reliant. It now often coincides with when parents are entering peak earning years and closing in on their own retirement. This continued financial support can strain one’s cash flow and hinder the ability to save enough money for the future. It’s undoubtedly difficult to tell your kids that you are limiting your financial assistance as they further their education. However, it will be even harder to ask them to bail you out if you don’t have enough money to pay your bills in retirement.
As strange as it might sound, planning for retirement today must also factor in college and career planning for one’s children. A sound plan includes picking a college that is affordable and will best prepare the child for financial success. This type of planning should start early by setting expectations so there are no surprises when the time comes to choose a University. This practical approach toward higher education will allow folks to ease their kids off their own payroll sooner by positioning them to become self-sufficient earlier.
A common refrain I hear from individuals a generation or two ahead of me is “back in my day things were simpler”. In reality, some things were simpler, but others were far more difficult. The truth is merely that things change over time. It’s important for investors to bear that in mind and refrain from anchoring their financial planning to what was done by previous generations. It’s best to have a plan that accounts for the way things are today and is flexible enough to adapt as circumstances continue to evolve in the future.
Disclaimer: This article authored by Jonathan Shenkman a financial advisor at Oppenheimer & Co. Inc. The information set forth herein has been derived from sources believed to be reliable and does not purport to be a complete analysis of market segments discussed. Opinions expressed herein are subject to change without notice. Oppenheimer & Co. Inc. does not provide legal or tax advice. Opinions expressed are not intended to be a forecast of future events, a guarantee of future results, and investment advice. Adtrax #: 3465931.1