A great deal of financial planning is based on myths. Especially common are myths about the best ways to save, spend, invest and draw on various sources of income. To dispel some of these myths, Bottom Line/Wealth spoke with one of the nation’s leading experts on personal finance and retirement planning, economics professor Laurence J. Kotlikoff, PhD, of Boston University. His myth-busting strategies for all stages of your adult life…
LOWER YOUR LIFE INSURANCE
Myth: Buy life insurance equal to seven times your annual wages if you are the big earner in the household.
Fact: Many people don’t need that much. Remember, the goal of insurance is to equalize your living standard across good and bad times, not to pay high premiums and deprive yourself and your family of spending money so that they can have a better lifestyle when you die. In fact, if your spouse is several years younger than you, or expects to retire much later than you, he/she may have more remaining lifetime earnings to protect than you do — even if you earn more in a given year. In this case, you may want greater life insurance coverage for your spouse. After all, your family’s living standard is being financed not just by current earnings, but by all future earnings.
RIDE A STOCK ROLLER COASTER
Myth: The older you get, the more you need to increase your investment portfolio’s allocation to relatively safe bonds and decrease the allocation to relatively risky stocks.
Fact: You might be better off putting your stock holdings on a “roller coaster.”
Reason: To reduce risk and maintain a more consistent lifestyle from year to year. Instead of diversifying just your investment portfolio, to balance safety and risk you need to focus more on how that portfolio fits in with your total resources. That includes job earnings and other income or benefits, such as inheritances, Social Security and Medicare.
How to adjust your allocations…
When you’re young, start with a relatively small stock allocation, perhaps under 20%, and put the bulk of your money in safer investments that you can more easily draw on, such as bonds, bank certificates of deposit and money market funds.
Reason: You may have relatively little in assets and earnings to draw on, weak borrowing capacity and high expenses for such things as a mortgage and kids’ educations.
Through middle age, increase your stock allocation dramatically, perhaps to 80%, because rising job earnings help to support your lifestyle and to diversify your overall resources. This is especially wise if you are approaching a time when the last tuition bill will be paid.
As you approach retirement, reduce your stock allocation, perhaps to under 40%. That’s because at this point, a sharp, prolonged drop in the stock market or the unexpected loss of your job could have a bigger impact if you have not started getting Social Security checks yet or begun drawing on other sources of retirement income, such as pensions.
In early retirement, increase your stock allocation to at least 50%, as you start drawing on such reliable income sources as Social Security.
Finally, in late retirement (after age 75), reduce stocks to 20% of your investment portfolio, as the risk for rising health expenses mounts.
POSTPONE SOCIAL SECURITY
Myth: If you retire early, you would be wise to start collecting Social Security benefits as soon as you reach age 62.
Fact: Retirees are often better off postponing the start of these benefits, possibly to age 70, especially as life spans grow longer on average.
Say that 66 is the age that the government calls your “full,” or “normal,” retirement age, and that you could start collecting $1,000 a month at that age. If, instead, you retire early at age 62 and start taking payments, your monthly check would be $750, or 25% lower (excluding cost-of-living adjustments).
If you wait until age 70, when the benefit you are eligible for would “top out” (except for cost-of-living increases), your monthly check would be $1,320. That means you would collect a total of $30,600 extra if you live to age 85, compared with the total you would receive if you started collecting at age 62.
Waiting until age 70 to start collecting is the right choice for most people, even if that means drawing more from your retirement accounts before age 70. This, of course, assumes that you have good reason to believe that you will live beyond your mid-70s, such as a history of parents and/or grandparents living long lives, and being in good health yourself.
For an estimate of your life expectancy, go to the “Living to 100 Life Expectancy Calculator” (www.calculator.livingto100.com).
An even better way: In many instances, you can choose to start collecting benefits at your full retirement age — which allows your spouse to start collecting benefits of up to 50% of yours — and then you can immediately “suspend” your benefits while your spouse keeps collecting his/hers. That way, you allow the size of your future checks to grow as you wait until age 70 to start collecting again.
Caution: If you are more concerned with leaving a bequest to your children and you have concerns about whether you will live much past 70, you may want to start collecting benefits earlier so that the money can help build up your assets sooner.