Threats make retirement planning challenging

By DAVID MOON, Moon Capital Management, LLC
March 31, 2013

If you are preparing for or enjoying retirement, there are a number of threats that can cause your well-designed plans to run into trouble. Don’t feel bad. Some of the most mathematically-simple problems are as emotionally difficult to solve for pension fund managers as they are for most individuals.

Threats are sometimes self-inflicted. Like a pension plan that haphazardly increases benefits and beneficiaries, some people simply spend too much. They continue to pay for their 25-year-old (and sometimes 45-year-old) kids’ bills like they were in middle school. They have too many cars. Things like that.

Sometimes a positive life event poses a financial threat. People often live longer than anticipated, which poses a risk for both traditional pension plans and individuals. Although a child born today is expected to live to be almost 76 years old, the typical 75-year-old male who is alive today will live to be almost 87 years old. Life expectancy figures take into account death from all causes, but most 75-year-old men are past the point in life they die from knife fights.

The most potentially devastating threat to your retirement planning is unrealistic assumptions about your investment returns. Interestingly, people are almost as likely to be unrealistically pessimistic as they are optimistic. And their expectations are, too often, unrelated to how their assets are actually invested.

Twenty-five years ago retirement planning was easy – or, at least, it should have been. In March 1983 you could retire and buy a 30-year Treasury bond at 8.6 percent, which was twice the then-current rate of inflation.

From 1983 to present, the median public pension plan annual return was 8.9 percent – or almost exactly the yield on the 30-year Treasury at that time.

Today, 30-year Treasuries yield 3.16 percent, or about equal to the rate of inflation. You can no longer beat inflation by simply buying a long-term bond. And if you buy a 10-year Treasury (1.90 percent) you are almost guaranteed to trail inflation.

Unlike 25 years ago, every dollar that an investor puts into 30-year Treasuries today dilutes his return.

Despite interest rates that have fallen by 65 percent, the average public pension plan today assumes a future rate of return of 7.80 percent, or about the same return it earned in the past 25 years.

Either this is incredibly unrealistic or these pension plans have made major changes in their asset mix in reaction to declines in interest rates.

That same quandary faces today’s investors.

For at least the past 25 or 30 years, as individuals approach and enter retirement, their financial advisors have told them to move some or much of their assets into less risky asset classes. And for most of the past 30 years, that meant bonds.

Today those same bonds are more risky than they are useful.

Those bonds are as much a threat to today’s retirees as they are to public pension plans.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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