Smart401k Blog

I read a report today from the Employee Benefit Research Institute (”EBRI”) that stated Americans have become more worried about the state of their retirement savings than they have been in the past. In fact, the number of people who are very confident that they will have a comfortable retirement dropped by about a quarter since last year to 27% (the largest drop in the surveys 18 year history). A lot of this is probably related to the current state of the economy and people’s uneasiness with the market. However, a number of things jumped out at me in the article that reinforced the need to build a nest egg now rather than in the future.

According to EBRI, 49% of surveyed individuals have less than $50,000 saved for retirement, and 28% have no retirement savings at all (if you exclude the value of their primary residence and defined benefit plans). This in and of itself is alarming, but what I found more alarming is what people believe to be an adequate amount of savings. According to the survey, 25% of individuals think they need less than $250,000, and an additional 16% of individuals believe they need $250,000-$499,000 in retirement savings. Now, I can’t say for sure whether they are right or not, but it seems awfully low when you consider things like increased life expectancy and rapidly rising healthcare costs. In addition, less than half of those surveyed had actually gone through the steps of estimating how much they’ll need in retirement (with a calculator or a financial advisor). Of those that did take the time to calculate their need, almost 50% made changes to their retirement planning (the most frequently cited change was to either start saving or to invest more).

It probably doesn’t surprise you that retirement savings is at the top of my mind, but what might surprise you more is that for most people it isn’t even in the top six of most pressing financial issues. It ranks behind things such as cost of living, insurance costs and paying down debt which are all important things. So you might be wondering what you can do to start building your nest egg without impairing your ability to live and pay the bills.

First, I would suggest calculating how much you might need to live how you want in retirement. This will show you how close or far you are from your retirement goal. If you want to experiment with the calculation you can try one of our calculators at http://www.smart401k.com/Calculate.aspx (I’d suggest using the calculator titled - Are My Current Retirement Savings Sufficient?). Its generally believed that you need to replace 70-80% of your pre-retirement annual income to maintain your current lifestyle. If you’re like me and want to travel the world, you might need as much or more than your current level of income. I also found it interesting to play around with rates of return on your pre and post retirement savings and number of years you’ll spend in retirement.

Next, I’d look at what you can do to make your retirement more secure. The easiest and probably most painless way to increase your savings is to increase your contributions to your 401(k). I wrote a previous post about what increasing your contribution by 1% can mean to you at retirement (”How much is a Latte Worth?“) … so give up that latte already! Then I would check to see if your plan has an auto-escalation feature, and if so, I would set it up so that your contribution increases by 1% a year. This will enable you to increase the amount you are saving without impacting your lifestyle (as long as you get a raise of more than 1% a year you won’t even notice the change). If you can do more than 1%, then do it, it’ll pay off in the future when you’re enjoying your retirement.

Scott H

Source: Employee Benefit Research Institute: The 2008 Retirement Confidence Survey

In the headlines

A look at some of the market movers over the past week:

• The Yahoo! (Nasdaq: YHOO) and Microsoft (Nasdaq: MSFT) drama ended when Microsoft pulled its bid
• Rumors flew that Deutsche Telekom (NYSE: DT) will be making a bid for Sprint (NYSE: S)
• Berkshire Hathaway (NYSE: BRK-A) investors flocked to Omaha for the company’s annual meeting
• More airline mergers could be in the works
• UBS (NYSE: UBS) continued to report losses
• Bank of America (NYSE: BAC) said that it is staying the course with Countrywide (NYSE: CFC) despite rumors to the contrary
• Oil is still unstoppable and Goldman Sachs (NYSE: GS) thinks it could hit $200 per barrel
• Sprint (NYSE: S) and Clearwire (Nasdaq: CLWR) announced a $14.5 billion WiMax joint venture
• Disney (NYSE: DIS) defied critics with its quarterly report
• Cisco (Nasdaq: CSCO) reported earnings that were good enough to calm investors
• AIG (NYSE: AIG) owned up to another huge loss
• Circuit City (NYSE: CC) is giving more consideration to the buyout offer from Blockbuster (NYSE: BBI)
• Citigroup (NYSE: C) is doing some more internal cleaning

Commentary

With the Federal Reserve meeting and its 25 basis point interest rate cut in the past, investors were free to get back to focusing on earnings reports. Earnings were a mixed bag and didn’t seem to be compelling enough to convince investors that either the trajectory of the economy will be worse than expected or considerably better than expected.

However, the week wasn’t without news that riled the market. Oil prices continue to loom large as a stumbling block for the economy and the projection from Goldman Sachs analyst Arjun Murti didn’t waylay anyone’s concerns. It’s particularly notable that Murti’s prediction didn’t come out of left field. In 2005 Murti said that he expected oil prices to rise as high as $105 through 2009 — a prediction that was obviously a bit conservative.

Additionally, the demise of the Yahoo! and Microsoft talks, as well as the rumors that Bank of America could walk away from Countrywide conspired to spook investors. The consummation of major acquisitions can be seen as a vote of confidence in the future, and it’s likely that investors are taking these data points as signs that major companies are getting less bullish about what’s ahead.

Looking ahead

We’re not through earnings season yet, and we can expect continued scrutiny with major companies like Sprint, Wal-Mart (NYSE: WMT), Freddie Mac (NYSE: FRE), Macy’s (NYSE: M), and Hewlett Packard (NYSE: HPQ) on deck to report next week. Expect that oil will also continue to be a big focus as high prices lead to more discussion over whether this is a potential lasting trend fueled by fundamentals or a shorter term speculative bubble.

Since the March lows, the market has recovered significantly. Despite the optimism, it’s questionable whether there have been any clear signs that the mortgage and credit crunch, and the related pressure on consumers, is truly behind us. This means that there is the potential for renewed pessimism to take the market back down a bit in the short term. However, we are still more than 10% below last October’s peak, so if this is a legitimate recovery in progress then we still have a ways to go.

Those on a steady investment schedule should continue at the same pace — that will still be the easiest path to good results. Investors with more flexibility in their investing may want to watch for any major dips for an opportunity to invest additional funds.

As I was waiting for my latte this morning, I began to wonder what it was worth to my retirement…..

• If you‘re 30 years old or younger it could be worth more than $60,000….
• For someone with at least 25 years until they will need the funds, it could be worth more than $25,000….
• And for someone with at least 15 years until they will need the funds, it could be worth almost $10,000….

You might be saying, “Wow, that’s a lot of money, but I just can’t alter my current budget?”

Well, you could start by drinking one less latte a week.  Increasing the amount you save in your 401(k) by $25 per month or less than $4.50 per week in take home pay (using a 30% combined tax rate) could help you build an additional nestegg for your retirement.

• For example, if you make $30,000 a year it would mean investing just 1% of you salary into your 401(k) plan. At $50,000 a year you would only need to defer slightly more than 0.5% of your annual salary.

What’s our point?  One of the most common statements people make is that they can’t save any more money or that increasing their deferral amount won’t be worthwhile.  Well, if you can skip one latte a week, you will be in a better place for your retirement.

Scott H

Methodology:  This example is for illustrative purposes only.  We used an investment schedule of $25/month, a tax-deferred account and an 8.5% annual return (this return does not represent the return of a particular investment option) to project the account balance

In the headlines

A look at some of the market movers over the past week:

• Mars, with the help of Warren Buffett and Berkshire Hathaway (NYSE: BRK-A), cut a deal to buy William Wrigley Jr. (NYSE: WWY)
• Visa (NYSE: V) shares fell despite reporting better than expecting results
• The major oil and gas players were reporting stellar numbers
• Citigroup (NYSE: C) raised another $4.5 billion in new stock to bolster its books
• Kirk Kerkorian continued to build his stake in Ford (NYSE: F)
• Home prices continued to plummet while foreclosures soared
• The Federal Reserve cut its target rate by a quarter point
• The US economy grew at an anemic 0.6% pace in the first quarter
• Economic reports continue to portray tough times, though some numbers have been better than expected

Commentary

Earnings continued to flood the newswires this week, though with somewhat less fanfare and impact. The majority of the reports came out of the technology and energy sectors, which investors seem to be less interested when it comes to projecting the direction of the broader market.

Despite the small size of the interest rate cut, the Federal Reserve had rapt attention from the market this week. The 25 basis point cut did end up meeting the expectations of most, but the statement released with the cut seemed to disappoint, since it did not make the Fed’s next move particularly clear. However, unless economic conditions deteriorate significantly before the next meeting, the most likely scenario is that the Fed is done lowering rates for the near future.

On the economic front, the picture is still little changed. Though the positive first quarter GDP growth was taken as a positive by some, the quality of the growth was poor, and most economists think we are still sliding. Other economic reports during the week showed a somewhat mixed picture — some confirmed the economic deterioration that has been widely projected, while others suggested that though the economy is weak it may not be slumping at as brisk of a pace as feared. Taken as a whole, it’s obvious that we have yet to hit an economic turning point, though it’s possible that the slope of the decline may be flattening out.

Looking ahead

When it comes to investing, risks run along multiple vectors. Often it can be difficult to pin down a good bet on multiple vectors at once, so the best approach is to try as much as possible to maximize exposure to the particular vector that you feel you have a handle on, while minimizing exposure to the others.

Two highly visible vectors in investing are direction and timing. Direction is simply which way the price of a particular investment will move, while timing is the schedule of when the movements will take place. We can surmise pretty easily that insight into both vectors at the same time would provide optimal results — in other words, you know which direction the market is headed and exactly when the turn is going to come. For practical purposes, though, timing has been an element that has often eluded the best investors and the smartest economists. For the individual investor it can be darn near impossible. This is exactly the reason why the investment plan that we recommend is one of continuous, steady investments over time. This strategy allows you to capture the gains from global growth trends while minimizing the risk of trying to time the market.

In these times of uncertainty, we continue to believe that this is the best strategy for individual investors to follow. Future growth in both the US and global economies looks promising, though the timing of the particular cycles are far less clear. Keeping a steady investment program is the best way to capture the former, while protecting your portfolio from surprise fluctuations in the latter.