Originally published on: July 1, 2013
Lightning never strikes twice in the same place. Feed a cold, starve a fever. What happens in Vegas, stays in Vegas. Like much conventional wisdom, all of these maxims are wrong. All are also examples of cognitive biases, which behavioral scientists suggest may outnumber rational thoughts in our complex and mysterious minds.
They also believe we think irrationally for sound evolutionary reasons, and that much of the time the results are positive. But there’s often a downside – whether electrocution or embarrassment. When it comes to retirement planning, conventional wisdom can do serious damage to our financial health. In a recent article Rande Spiegelman, VP of Financial Planning for our partner Charles Schwab has punched holes in five familiar pieces of conventional wisdom.
1. 70%-80% income replacement. Popular belief says this should be enough to retire on. In fact, health care costs or travel and leisure expenses can easily make up for any decrease in other needs. He cites data showing that about half of retirees needed just as much or more income when they retired. We’d add that the “sandwich generation” of Baby Boomers faces additional challenges. They may still be caring for elderly relatives as they retire themselves. And because their children often become truly self-supporting quite late in life, the more affluent may find themselves still on the hook for college loans, graduate school tuition, or home down payments.
The same can be said of the “4% Rule” for withdrawals and similar rules of thumb. As the population of retirement savers becomes more diverse, and their financial needs grow more complex, one-size-fits-all solutions just don’t make sense anymore – if they ever did.
2. Lower tax brackets. If you’re lucky, other sources of income may add up to more than you think, keeping you in a higher bracket. If you’re not, today’s historically low tax rates may trend upward in the future. Either possibility involves some unknowns, but the latter part is truly unknowable. It’s worth noting how many IRA investors cope with a similar decision when choosing between Roth and traditional versions. Hoping for the best while planning for the worst, they fund one of each.
3. Working in retirement. This may be true for a while if your health is good, and if the economy is too so you can find an appropriate job. In practice many people do work while in (semi-) retirement. But Spiegelman points to research indicating that almost half of retirees stopped working before they had planned. A better approach might be to continue your regular job for just a few more years. That way you can put away additional savings at full pay into your retirement accounts. Along with an increased savings rate, this is the strategy our advice system often recommends to GuidedChoice investors.
4. The stock market. It’s hard to imagine anyone still believes a roaring market will make up for inadequate savings, but irrational exuberance has a very short memory. On the other hand, it can be just as dangerous to abandon the market on the equally irrational belief that downside risk will wipe you out. Looking at historical returns for various asset classes should be reassuring. But once you’re on board with the concept of long-term growth, the truth of the matter is, like most things, pretty complicated. Details of how much you can prudently expect from financial markets is best left to the professionals (see myth #7 below).
5. Social security. The future of this program is even more difficult to predict than market performance. Its fate will depend on policy and politics as well as economic fundamentals. We agree that over-reliance on future payments is unwise. For our own investors, we make a default assumption that Social Security will be there – but also give them the option to remove it from the calculations.
The five “big lies” addressed in the Schwab piece are probably the most commonly known and believed. Within and around our industry, however, there are plenty more, shall we say, “misconceptions.” In the spirit of debunking, we look at a couple of these below.
6. Small businesses can’t offer a retirement plan. Many small businesses have faced a world of challenges just staying afloat over the past few years, so this one is easy to believe. But a growing number of business owners disagree. A recent survey from Sharebuilder 401(k) found that 24% of businesses with fewer than 50 employees now offer a 401(k), up from 10% in 2008.
Why now? According to the company, “It appears that [the Great Recession] was also a wake-up call when it comes to planning for the long term.” With their own investments now recovering rapidly, 82% of business owners see 401(k) as an effective way to save for retirement. And of those who offer one, fully 89% say it’s an important way to attract and retain talent. The firm projects that the numbers will continue to rise as business owners realize barriers to offering a plan are much less significant than they had believed – especially if SEPs and payroll-deduction IRAs are on the table.
7. Professional advice is out of reach for most people. This was true years ago – when financial advice required a sit-down in an advisor’s office, and the Internet required a dial-up modem and a lot of patience. Times have changed. In an upcoming article for Money Magazine, Penelope Wang reveals “the best-kept secret in 401(k)s: free or low-cost professional investment advice.”
Using a broad definition of help, she finds that fully three quarters of plans offer some kind of assistance. She also makes a strong case for what we believe is the best kind of advice, professional account management. We would add that managed accounts have broken out of the plan world and are now available to virtually all retirement investors through low-cost IRA platforms.
Fighting conventional wisdom can be challenging. Consider Columbus, who struggled against conventional views of the size and shape of the Earth to raise support for his first expedition. Then consider the (literal) world of possibilities that voyage opened up. With his example in mind, we’ll keep working to dispel the flat-earth myths of our own industry.