Investors often worry about their retirement, especially during market corrections. About half of Americans polled by benefitspro.com believe they will need a “miracle” to reach their basic retirement goals.
Fortunately, miracles are not necessary if you do a little planning. If you understand key risks and get cash flow under control, you can enjoy a stress-free retirement.
Identify the main risks
It’s important to understand the potential financial risks if you want to retire in a comfortable position. Fear causes discomfort and is difficult to overcome if there are too many unknowns. Education and careful planning are great tools to allay these concerns.
The most significant financial risks in retirement are:
- Longevity: You can outlive your money.
- Inflation: Rising prices reduce the purchasing power of your assets and your cash flow.
- Interest rate: Low yields reduce the investment income available for retirement portfolios.
- stock Exchange: Your savings lose value when asset prices fall.
- Expenses: Higher than expected cash needs may be due to health care, housing, or a higher standard of living (such as cell phone bills that were irrelevant 20 years ago).
There is a common theme running through the above risks – they are all related to liquidity and cash flow. Retirement planning is about making sure you have enough cash to cover your financial needs.
Sources of cash
Everyone has different sources of retirement income, but there are a few different categories that produce the vast majority of cash flow. First, most retirees receive social security benefits. The amount of benefits received depends on the amount of income earned throughout your working life and the age at which you choose to start receiving benefits.
In general, the more you earn, the bigger your Social Security checks will be. You can also increase your benefits by delaying the start of payments. Currently, the maximum monthly benefit is just under $4,200, while the average benefit is around $1,660.
Some retirees have pensions, although this has rapidly become less common in recent decades. Pensions provide guaranteed payments to retirees, usually on a monthly basis.
Most people don’t have a pension to supplement Social Security income, but it’s still an important piece of the puzzle for millions of households. The typical retirement benefit is between $1,000 and $2,000 per month.
Many households rely on accumulated assets to meet their retirement lifestyle goals. Retirees hold liquid assets in 401(k) accounts, traditional and Roth IRAs, brokerage accounts, and cash. When people need cash, they can withdraw funds from their various accounts.
Investments also produce income and growth that can be used to pay for living expenses in retirement. Many retirees are able to support themselves through regular dividends and interest earned in their investment accounts.
Build and manage retirement investments
Once you know the amount of guaranteed income you will receive from Social Security and pensions, you can calculate the required cash flow from accumulated savings and investments. In my opinion, it’s impossible to find a magic number you’ll need to retire comfortably – there are too many variables that can impact that number over a period of a few decades. Nevertheless, there are important rules that you can use as reliable guidelines.
The 4% rule suggests that you can safely distribute 4% of your retirement account each year without running out of money. This has been revised downward in recent years due to low interest rates, rising health care costs and longer life expectancies. At a minimum, you should plan to have $250,000 in an investment account for every $10,000 of after-tax annual cash flow required in retirement.
Incorporated tax obligations are important to consider. Withdrawals from your 401(k) assets and traditional IRAs will be treated as ordinary income, while Roth IRAs and qualified dividends in a brokerage account could avoid taxation.
It’s likely that most households will need more than $1 million in savings to meet their retirement lifestyle goals. This figure may seem daunting, but it can be achieved with systematic savings and a long-term investment strategy that balances volatility and growth.
Households should strive to save 20% of their annual income. Common strategies for improving savings rates include taking full advantage of employer 401(k) matches and sticking to a spending budget.
When you are relatively young, you should prioritize growth with your retirement funds. Short-term volatility is irrelevant for people who have not been selling for several decades and who have time to go through several market cycles. The focus on long-term growth should help you outpace the market.
As you approach retirement, you will have to sacrifice some growth in order to reduce volatility. Owning valuable stocks and bonds will save you from suffering catastrophic losses in a potentially bearish market before you retire.
If you can save $1,000 a month and invest it for an average return of 6%, it will take you just under 30 years to reach $1 million. It’s easier said than done, but there’s a plan to make it happen, and it should really help deal with the major risks in retirement.
Understanding your sources of retirement income is the best way to develop an effective financial plan for your retirement years. A lot will change along the way, but staying focused on cash flow is key.