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Retirement Myths and Truths
Retirement Investing: Exposing the Myths
By John Henry Low
Times have changed, and so have investing principles. Many current investment practices were learned in the 1970s, an inflationary period and a heyday for stock and bond brokers. But today, technology has arrived, rationalization and globalization are key words, and investment realities have shifted in kind. We are living longer, retiring earlier, and relying less on traditional savings vehicles and more on ourselves. All of these factors lead to some material changes in the way we save and in the investment principles that we learned long ago.
So why is investing for our own retirement more crucial than ever? To begin, life expectancies well into the 80s mean we face retirement spans of 20 years or more. We are also retiring earlier, forfeiting income for leisure, and relying less on traditional retirement savings vehicles such as Social Security and pensions.
Look at the facts:
Traditional retirement savings vehicles are falling short. Social Security will probably still exist in the future, but contributors can count on reduced benefits and longer waiting periods. As it stands now, Social Security payouts will exceed incoming monies by the year 2020. Pensions are getting rarer.
Inheritance can be a great windfall, but the median inheritance is only about $30,000 per person and can quickly be depleted in unforeseen medical bills. While 401(k) plans are still a great source of savings for most people, annual contributions are limited, and many people underutilize them by not investing the maximum allowable, or investing in their company's stock or in conservative investments for "safety."
So our future financial security increasingly depends on the investment decisions that we make today. But many of us don't invest wisely. Below are six common fallacies regarding retirement investing.
Myth 1: Bonds are the best retirement savings vehicle.
All quite true until 1979 when the picture changed dramatically. Why? After the collapse of the gold standard in 1972, the Federal Reserve (the one body that has more power to affect our investments than any other) struggled with its focus. Should it target unemployment, inflation, or growth, and how should those targets be achieved?
But everything changed in 1979, when the Fed came under the leadership of Paul Volcker. After years of oil shocks and high inflation rates, monetary policy at the Fed began to encourage price stability. At first, Volcker targeted money sup-ply to control inflation. But by 1982, he realized that the supply of money was increasingly difficult to measure, and switched his focus to targeting interest rates. Either way, interest rates soon went into double digits, and investing has never been the same.
Fact: The volatility of bonds has increased substantially as a direct result of this change in Federal Reserve monetary policy. This means that bond prices fluctuate more rapidly and widely than ever before and could result in larger losses. With such price fluctuations, the opportunity costs of holding a long-term bond can be greater. (The opposite is true for stocks, whose steady growth has minimized their relative volatility over time.)
Myth 2: Bonds perform better than stocks over the long run.
Fact: Stocks perform better than bonds over the long run; however, they are more volatile on the short-run. Your investment time horizon and risk tolerance should determine what type of investments to use.
Myth 3: Buying individual bonds is best.
Interest rates have been at historical lows, and we wouldn't bet on rates falling further. Remember, rising or falling interest rates will not only dramatically affect the market value of your bonds but will also affect what types and maturities of bonds to hold going forward. Cost is another factor. Thinly traded or illiquid bonds, such as many municipal bonds, can carry spreads or implicit trading commissions as high as 5 percent.
Fact: Few of us have the time or expertise to accurately "shift" the maturity structure of our bond holdings to capture the benefits of falling rates and monitor credit quality to avoid losses. Bonds are an important part of any retirement plan, but buying individual bonds may not be the best strategy. It is generally better to use a good bond mutual fund and leave the maturity shifting to the experts. You have the added benefit of being diversified among a large number of bonds with varying maturities. With over 7,500 mutual funds offered today, you can find one to meet almost any investment criteria.
Myth 4: Return is all that really matters.
Fact: Inflation, taxes, and fees can go a long way toward eroding your retirement income goals. Make sure you take inflation into account when targeting your retirement income. Always consult with a tax expert when setting up your retirement plan and when starting to draw from it. Be aware of how much you are paying in fees and commissions. Alternative investments may be less expensive.
Myth 5: A successful investment plan doesn't touch principal.
Fact: Earning higher returns over the long-run, in many cases, makes it worth-while to "dip" into principal.
Myth 6: When it comes to investing for retirement, the safer the better.
Fact: With a time horizon of 15 to 20 years, invest in a well-diversified portfolio, emphasizing equities (domestic; international; growth; value; large-, mid-and small cap), bonds, and cash. Mutual funds are a great alternative for diversification and risk reduction. Know your risk tolerance and time horizon, and invest appropriately. Don't hesitate to call a professional if you need help in structuring or restructuring your investments. Your future financial security is too important to neglect.