Four Steps To A Better Retirement
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Four Steps to a Better Retirement

Retirement is the primary reason we save for the future. It’s the single largest financial concern for most investors. But most Americans are not on target for the retirement they envision. A 2010 Employee Benefit Research Institute study found that about half of workers have less than $25,000 saved for retirement. Just over half have not even thought about what they’ll need. Many don’t prepare because it’s a complicated process. But Americans are living longer and receiving less from pensions and government programs. That’s why it’s ever more critical to plan smarter.

Whether you are in the middle of your career, or well past your working years, this guide details four steps to achieve a more satisfying retirement.

  1. Get Organized & Set Goals
  2. Formulate a Savings & Withdrawal Strategy
  3. Invest Wisely
  4. Be Prepared & Stay on Target

Step 1 – Get Organized & Set Goals

Get Organized

Be strategic. You can’t plan for the future if you don’t know where you currently stand.

It starts with spending. Develop a budget and track your expenses. It is critical you have a handle on cash flow—it will help determine how much you can save and offer insight into discretionary versus non-discretionary expenses. If you’re retired and find yourself spending too much, this will help identify areas to cut back.

Understand what you have to determine what you need. Just as important, but perhaps more difficult to calculate, is the current state of your assets. Houses and physical assets are easily quantified, as are investment portfolio values. But this is just the beginning. The vast majority of investors have multiple accounts spread across several institutions—a current 401k, an old 401k, a savings account, an IRA here, a taxable account there. There’s a good chance you’re richer than you think.

Get organized. There are two key ways to stay on top of your investments. The first is to track your assets via manual spreadsheets. This can be a tedious process, requiring a great deal of time. The other option is to utilize a free online tool. Personal Capital can help you monitor your investments easily and securely, doing all the legwork for you.

Unless you’re painstakingly tracking all your investments in a spreadsheet, chances are you don’t have a firm grasp on your true asset allocation and how you are positioned. Within your investment portfolio, understanding your aggregate asset allocation is imperative. Studies show it is the single most important driver of long term returns. If spreadsheets sound too tedious, Personal Capital’s award winning free service can help you to track your income, spending, assets and liabilities. It can also provide a holistic asset allocation breakdown by aggregating your various investment accounts and other personalized investment help.

Getting organized might seem daunting, but it’s easier than it sounds! By spending just a few moments you will be able to set a strong foundation for informed decision making.

Set Goals

Understand where you want to be. Once organized, it’s time to set goals. When do you want to retire? How much do you want to spend per year? Do you have assets you would like to leave to heirs? To a charity? Answering these questions will help determine your savings and withdrawal strategies.

If retirement is too far off for specifics, try framing these questions differently. For most people, maintaining their current lifestyle in retirement is the primary objective. Does this apply to you, or do you expect to increase or decrease your standard of living? Rough estimates are better than no estimates.

It is important to understand how other spending goals impact retirement. Sending your kids to college, for instance, could potentially extend your working years or reduce your targeted standard of living. Knowing the impact will help you better assess the importance of non-retirement goals. The last thing you want is to run out of money and have to start a new career when you’re 81.

Don’t feel like you need to iron out every detail, and try not to get frustrated when you hit road bumps along the way. You will hit road bumps. That’s why your financial plan and investments should be dynamic and fluid—as your life and goals change, so should they.

With an organized foundation and basic vision of the future, you can begin formulating savings and withdrawal strategies and properly position your investment portfolio.

Step 2 – Formulate a Savings & Withdrawal Strategy


If you are in the middle of your career and accumulating assets, this section applies to you. If you are already retired or about to retire, skip ahead to the withdrawal section.

When it comes to saving, there are two major variables: how much and where.

1) How much to save?

For most people, the right amount is whatever allows relatively smooth consumption over their lifetimes. With so many variables, and over a long time horizon, this can be tricky to calculate. You need to save enough but you don’t want to live below your means either—balance is key.

Try not to get complacent about saving just because you still have plenty of time until retirement. Due to the magic of compounding, saving early helps disproportionately and can make things a lot easier in your 50’s and 60’s.

For example, let’s assume you max out your 401K, saving $17,000 every year starting at age 25. Assuming a 7% return, you will have about $3.4 million at age 65. If you wait until you’re 40 to save, the final amount drops to $1.1 million. For perspective, adjusted for 3% inflation and 20% tax, these sums would allow relatively safe withdrawal rates of $125,000 and $40,000, respectively. Coupled with Social Security, these values may be sufficient to meet many people’s retirement goals, but you can see the huge impact of getting started early.

A general goal for retirement is to accumulate assets worth at least 20 times the amount you want to spend each year, not counting money received from Social Security or pensions. This can include your home, but only if you are willing to sell it.

If this number seems too far off and daunting, set up smaller checkpoints along the way. With 4% inflation adjusted returns, the real value of your assets will double every 15 years, roughly speaking. This means if you can reach 7 times your expected withdrawal amount by 15 years before your retirement, you’re in good shape – as long as you can continue to save.

Here’s an example:

Desired Annual Spending in Retirement: $100,000
Expected Social Security: $30,000
Shortfall: $70,000
Desired Nest Egg at Retirement: $1,400,000 ($70,000 x 20)
Target Nest Egg at 15 years to Retirement: $490,000 ($70,000 x 7)

2) Where to Save

Saving in the right accounts can make a big difference in your retirement. Assuming a 25% tax rate, a 40 year old maxing out their 401K will retire at 65 with about 40% more money than if she saved equally in an after-tax account (assuming the tax savings are also invested, not spent). It is true she will eventually owe tax on the 401k balance, but the impact should still amount to about 25% more spending power in retirement. This makes a huge difference.

Every situation is unique, but these guidelines should help:

  • If your company matches 401K contributions, always participate up to full amount of the match. Always.
  • Generally speaking, put as much in your 401K or other tax-deferred retirement plan as you can afford. If you are self-employed, make use of a SEP IRA.
  • If you don’t have a 401K plan, contribute the maximum to an IRA.
  • If you are eligible for a Roth 401K or IRA, making the right choice is beyond the scope of this paper. Diversifying 401K contributions between a Roth and Traditional is often reasonable.
  • Avoid using savings to pay down your mortgage unless you are stuck in a loan paying over 5%.
  • The exception is if you are risk averse and will not be investing much money in stocks, then it is better to pay down a mortgage than sit in cash or low yielding bonds.
  • If you are stuck with a high rate loan, see if you can refinance.
  • If you have children who you are fairly certain will attend college and you want to pay for it, contribute to a 529 account only after you have maxed out your 401K or IRA.
  • Don’t keep excessive cash in a low-yielding checking account. At most, a few months of expenses. Excess cash should be invested or at least placed in higher yielding savings accounts or CDs.


A withdrawal strategy is the exact opposite of a savings strategy, but the same factors are at play: how much and where.

1) How much to spend?

Many people spend too much, too fast. Others, constrained by fear, can be overly frugal.

Many people make bad investment decisions because our brains are poorly equipped to deal with volatility. After a few years of high investment returns, many people get comfortable spending at a higher rate because they still see their balances go up. Humans are wired to extrapolate current trends into the future. We begin to think our investments will continuously generate income. It takes a lot of discipline to avoid this trap.

Understanding the timing of investment returns is also very important. Someone who retired in 1992 could withdraw in excess of 7% of their portfolio annually and still watch their balances grow. This is not the case for someone who retired in 1999.

Most financial planners suggest limiting portfolio withdrawals to 4% per year. Historically, 5% withdrawals are generally safe. Here are some guidelines we find useful for retirees who need their money to last for at least another 25 years:

  • 4% is a very reasonable annual withdrawal rate. If 4% is too restrictive, 5% is also reasonable, but be prepared to reduce spending during poor performing years.
  • Portfolio withdrawals above 6% annually should be considered depletionary, but there is about a 50% chance the gamble pays off and you can sustain them over the long-term.
  • You can’t gamble with aggressive withdrawal rates if you are unwilling to gamble with a relatively high equity allocation. High withdrawal rates coupled with mostly bonds is usually disastrous.

Other questions to consider:

  • Do you have real estate or other assets that can be sold if necessary?
  • How much can you rely on Social Security and other income such as pensions or annuity payments?
  • Will your children support you if necessary?
  • Does your spouse place a higher priority on current expenditure or future safety? This may be an uncomfortable conversation, but a necessary one in certain situations.
  • Are future medical expenses covered? This area is commonly underestimated.

2) Which Accounts to Draw Down?

Here is the industry standard for ordering withdrawals:

  1. Taxable Accounts (Individual, Joint, Trust, etc.)
  2. Tax Deferred Accounts (IRA, 401k, 403b, etc.)
  3. Tax Exempt Accounts (Roth IRA, Roth 401k)

The idea is to defer taxes as long as possible and maximize tax deferred or tax exempt growth. It can make a big difference, often extending the life of a retiree’s assets by years. Once you hit 70½ you will have to take required minimum distributions, or RMDs.

This simple rule works well and is good enough for most people. But those with complex tax situations may benefit from a more sophisticated analysis. Here are some common exceptions to the rule:

  • If a disproportionate amount of your assets are in retirement accounts, withdrawing a small amount until you hit the 25% federal tax bracket may make sense.
  • If you have high income in retirement and leaving money to heirs is not a high priority, spending down a Roth can help lower taxes.
  • If you have highly appreciated assets in a taxable account that may benefit from a step-up at death, it often makes sense to maintain them and spend from retirement accounts instead.
  • Roth conversions may be beneficial in certain situations.

Step 3 – Invest Wisely

Well thought out goals and a solid savings plan are essential, but they mean little without a strategic investment approach. Here, we list three critical decisions you should make before buying a single stock, bond or mutual fund. We also provide some tips to minimize headwinds caused by taxes and fees.

Critical Decision #1: Self vs. Professional Management

Many individuals manage their own investments. While there is nothing inherently wrong with this approach, average investors can have difficulty setting aside emotions. This often leads to rash investment decisions that are more reactionary than calculated. Take the last downturn for example. The market’s drop sent investors running for the hills—ditching equities in favor of cash. And it left sizeable emotional scars. Many retirees saw their nest eggs cut almost in half. Out of fear these investors remained in cash, waiting for the “all clear” signal and missing much of the huge rally since the market’s March 2009 bottom. Unfortunately, this emotionally-charged decision is forcing some retirees to return to work, or at least significantly reduce their standard of living.

When done correctly, there’s nothing inherently wrong with self-managing assets,and professional managers can make similar mistakes. But on the whole self-managing investors tend to do more harm than good. Market research firm Dalbar compiles an annual study of investor behavior, and recent findings support this theory. In 2011 alone, the average equity mutual fund investor lost 5.7%, despite the S&P 500 being up 2.1%. That’s a sizeable difference, and it’s precisely because investors succumbed to fear, making the wrong decisions at the wrong times.

Alternatively, you can hire a professional. If chosen correctly, an advisor can significantly boost your odds of a successful retirement—they help you make objective decisions and generally have more investment knowledge and experience. But if chosen incorrectly, they can make matters much worse.

The type of advisor can make a difference. Brokers are paid on commission, meaning they often make money selling investments to, and buying investments from, clients. This is problematic because it creates conflict of interest. What’s to stop a broker from simply recommending investments paying the highest commission? In fact, often times this is exactly what they do. Even brokers who mean well can’t fully avoid conflict of interest—it’s embedded in the business model.

Instead, find a professional whose interests are aligned with yours. Fee-based investment firms, often called RIAs (registered investment advisor), charge clients based on assets under management, not commissions. This means their interests are on the same side of the table—they too benefit from increasing asset values. Since there is no incentive to sell inappropriate products, these firms can provide truly objective and unbiased advice.

Unfortunately, it can be hard to know when you’ve found a good financial advisor and when you’ve found a good salesperson. The best advice we can give is to look at several options, ask a lot of questions and trust your gut. And if you have an advisor you are unhappy with, don’t be afraid to move on.

Critical Decision #2: Active vs. Passive

The next key decision concerns management style: active or passive? Active management is the belief one can outperform the market through superior stock selection, or by over/underweighting specific categories. Conversely, there are no active investment decisions involved in passive management—it is the attempt to mimic a specific index and match its return.

Passive investing is gaining popularity. According to the Investment Company Institute, net passive mutual fund assets increased from $371 million in 2001 to almost $1.1 trillion at the end of 2011. But this only represents a small slice of the $11.6 trillion domestic pie. Actively managed funds still account for over 90% of U.S. fund assets.

Which management style has a better track record? To answer this question, S&P puts together an annual report ranking the returns of actively managed mutual funds to passive S&P indices: the S&P Indices Versus Active Funds (SPIVA) Scorecard. On a one-, three- and five-year basis, the S&P 500 outperformed 81%, 69%, and 62% of all domestic large cap mutual funds, respectively. The same trend is present across the mid and small cap spectrums. In fact, no ten year period exists where a majority of actively managed mutual funds outperformed their benchmarks.

The reality is most active fund managers leave their customers with less money than passive indexing. And diversifying across multiple funds isn’t the answer. Simple math dictates the odds of underperformance increase as more active funds are added to a portfolio. Investors should even be wary of managers with strong track records. History is littered with examples of star managers who attracted considerable assets and performed terribly thereafter.

Given low odds of outperformance for active funds, we believe passive indexing is the more prudent approach to investing. This applies to savers and retirees alike.

Critical Decision #3: Asset Allocation

Whether you use active or passive investment vehicles, asset allocation is the most important investment decision you can make. This refers to the percentage of stocks, fixed income, alternatives, and other asset classes held in your portfolio, and studies show it is the single largest driver of long-term returns. It is the cornerstone of modern portfolio theory.

The table below shows correlations of various asset classes relative to each other. A value of one implies the assets are perfectly correlated—they always move in the same direction at the same time. A value of negative one means the assets move in opposite directions, and a value of zero implies the assets are uncorrelated.

Asset Class Correlation Matrix
Domestic Equity International Equity Domestic Fixed International Fixed Alternatives Cash
Domestic Equity 1.00
International Equity 0.66 1.00
Domestic Fixed 0.04 -0.08 1.00
International Fixed 0.00 -0.12 0.88 1.00
Alternatives -0.31 -0.20 -0.24 -0.23 1.00
Cash 0.00 -0.03 0.19 0.46 0.08 1.00
Produced by Personal Capital Corporation

As the table shows, these assets classes behave differently from one another, so owning a combination of two or more can actually reduce portfolio volatility. Said another way, if one asset class decreases in value, another would hypothetically increase and mitigate the impact. The traditional approach is a basic combination of domestic equities, fixed income and cash. But this should be taken further. Construct a global multi-asset class portfolio utilizing all available liquid asset classes. As seen in the two figures below, this can actually reduce overall portfolio risk while simultaneously increasing return—the Holy Grail in investing.

Traditional Three Asset Class Portfolio Global Multi-Asset Class Portfolio
Domestic Equities 60% 40%
International Equities 0% 20%
Domestic Fixed Income 25% 15%
International Fixed Income 0% 10%
Alternatives 0% 10%
Cash 15% 5%
Sum of Weights 100% 100%
Expected Returns 7.8% 8.0%
Standard Deviation 12.4% 11%
Sharpe Ratio 0.35 0.41


The appropriate asset allocation should be tailored to your personal financial situation, accounting for your risk tolerance, time horizon, expected withdrawals, and legacy wishes, among other factors. In every scenario, investors should seek the highest return for the right level of risk. The right level of risk is a factor of both ability and willingness to accept risk. An investor may say they’re highly aggressive, but short term cash flow needs, for instance, may limit their ability to prudently assume high risk.

Alternatively, some investors should assume more risk than they may be comfortable with. Being too conservative can be a big mistake, but accepting a lower expected return may be a worthwhile tradeoff if it means sleeping better at night.

Eliminate Portfolio Headwinds

Even with all the correct macro level decisions, investors still face numerous portfolio headwinds. The two largest are taxes and fees. Both can weigh on performance and significantly impact retirement.


Poor tax management could cost you up to 25% of your long term return and severely limit your spending power in retirement. Mutual Funds are notoriously bad at tax management—high turnover often creates large tax bills each year. And depending on when you buy a fund, you may even have to pay capital gains on profits other people made. When you buy a fund, any embedded gains come with it. A 2010 study by Lipper (Taxes in the Mutual Funds Industry – 2010; Assessing the Impact of Taxes on Shareholder Return) showed owners of mutual funds in taxable accounts gave up an average of 0.98% – 2.08% in annual return to taxes over the last 10 years. That’s a sizeable headwind.

Relative to mutual funds, Exchange traded funds (ETFs) are a step in the right direction. In fact, greater tax efficiency was the primary reason they were created. But the best way to mitigate taxes is to create a portfolio of individual securities, or a combination of individual securities and ETFs. This allows for tax management on multiple levels. With a wider set of options to meet cash flow needs, it’s easier to defer gains into future years. And if you have to sell low basis positions, you can harvest losses from poor performers to mitigate or neutralize the impact.

If you have taxable and tax-deferred accounts, you can also tax locate. This involves placing higher yielding securities in tax-deferred accounts to shield their income. Additionally, income from most REITs and bonds does not qualify for the same favorable tax rate as stock dividends. It is advantageous to strategically place these securities in tax-deferred accounts. Combined, these tactics help maximize total portfolio value and reduce your annual tax bill.

Excessive Fees

Most people don’t actually know how much they pay for investment management or fund fees, and unfortunately it is often much more than they realize. Not all fees are easily understood, and many are embedded deep within investment products making them difficult to see. Over time they can be a significant drag on investment returns. Always know what you pay in fees. Aggregating your accounts on your Personal Capital Dashboard can help.

Professionals. Investors who choose to hire a professional often pay annual fees based on assets under management. Amounts vary wildly, but typically range from 1% of assets on the low end to 3% on the high end. Some advisors directly pick stocks, while others pick mutual funds (often called wrap accounts or fund of funds). Paying anything near the high end of that range is almost never warranted, particularly for those picking mutual funds which come with their own set of fees. And if you use a broker, you could be paying sizeable commissions on each and every investment you make. Annuities are notorious for such commissions, which is why brokers are so quick to recommend them. So when hiring a professional, make sure you clearly understand what they charge, as well as any commissions you might be responsible for. While it seems silly, many investors have no idea they pay almost 3% a year in fees to their advisors.

Fund Fees. According to the Investment Company Institute and Lipper, the average expense ratio of equity funds is 1.43%. And expense ratios are just the beginning. Mutual funds carry several additional costs – some visible and some hidden. These can include sales loads, which are paid to the selling broker, as well as similar fees paid to the fund company. There are also embedded costs associated with trading, research, and potential market impact (hidden fees). Add these up and the real cost of owning mutual funds is often 2% to 3%, or more. These are huge hurdles to overcome considering most funds don’t outperform their respective benchmarks. And this doesn’t even include the impact of taxes. The best way to avoid excessive mutual fund fees is to avoid mutual funds altogether (at least active mutual funds). ETFs are often cheaper, more tax efficient alternatives.

Step 4 – Be Prepared and Stay on Target

In retirement planning, just like a diet, losing weight is only half of the endeavor. The other half is keeping it off. This means you must continuously monitor your progress and ensure you remain on target. There are plenty of potential road bumps that can threaten your golden years, so it is wise to be prepared.

One of the cardinal tenets of prudent financial planning is setting aside a cash reserve. This money should be liquid and easily accessible in the event something unexpected occurs, like losing one’s job. Without it, you may be forced to dip into retirement savings to meet expenses, which could result in hefty tax bills and penalty fees. It’s generally recommended a cash reserve be high enough to cover three to six months of expenses, although the actual value depends on your specific situation.

You should also consider insurance needs, particularly life, disability and long-term care. Life and disability insurance typically apply to those saving for retirement. The loss of an income, be it through death or disability, can be financially devastating if not properly planned for. It can push stay-at-home spouses back into the workforce and eliminate the possibility of retirement altogether, let alone achieving any other financial goals. So having a safety net can make a lot of sense, particularly for families with a sole breadwinner. But insurance isn’t for everyone. Those with significant liquid assets and/or no immediate family can probably go without. For those in need, make sure to take advantage of any coverage offered through work before purchasing from a third party. Work plans are typically offered at a significant discount to market rates.

Long-term care insurance is growing in popularity, and for good reason. According to the US Department of Health and Human Services, 70% of people age 65 and over will need long-term care services at some point in their lives. Additionally, it costs on average more than $70,000 a year for a nursing home stay. That’s not cheap. So if paying for a year or two would significantly dent your assets, it may make sense to consider insurance as a backstop.

To A Better Retirement

If your life changes, so should your retirement plan. On an annual basis, revisit step one: get organized and make sure your goals are on the right track. Stay on top of your investments with our free Investment Checkup tool, which analyzes your investment portfolios for risk. Run your portfolios through our 401k/Portfolio fee analyzer to see how much portfolio fees are robbing you from a healthier retirement. Finally, track your cash flow using our easy-to-use financial dashboard to make sure you’re always spending less than you earn.

If you have any questions or are seeking personalized advice for your specific situation, please give us a call at (855)855-8005.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Craig Birk leads the Personal Capital Advisors Investment Committee and serves as Chief Investment Officer. His focus is translating improvements in technology into better financial lives. Craig has been widely quoted in the Wall Street Journal, Bloomberg, CNN Money, the Washington Post and elsewhere. Prior to Personal Capital Advisors, he was a leader within the portfolio management team at Fisher Investments, helping assets under management grow from $1.5 billion to over $40 billion. Craig graduated from the University of California at San Diego and has earned the Certified Financial Planner® designation.
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