Mutual Funds Have Limitations

Last updated on May 13th, 2019 at 02:36 pm

If you are turning 60 this year or approaching retirement, you are not alone. Almost 3 million baby boomers will turn 60 this year, and many of them will find themselves financially unprepared for retirement. Unfortunately, most retirees think that having the magic number of dollars in their investment portfolio is the only question to ask before retiring. There are many other important questions that retirees need to ask to financially optimize their retirement.

Most people contemplating retirement arrive at a magic number representing the amount that they want their investment account to grow to before they retire. Although it is an important exercise, this magic number is only one input into a complex formula that will help determine a successful retirement.

I define a successful retirement as "A place in life where you will not only never run out of money, but will also not have to worry about it." In order to help ensure a successful retirement, you will need to answer a laundry list of questions.

  • How much money do I have in my investment portfolio?
  • How much do I plan on spending per year?
  • What is my life expectancy?
  • How much do I plan on leaving behind to my beneficiaries?

As a general guideline, a safe annual withdrawal rate after Social Security and pension income is 4 percent of your portfolio. Although many retirees think that this number is low, they forget one of their worst enemies: inflation. At 3 percent inflation per year, $50,000 today is equivalent to $100,000 in 25 years. Those who are counting on a more sedate lifestyle in their 80s often neglect to factor in the odds of increased medical costs.

As life expectancy has grown, the number of years in retirement has increased dramatically. In 1935, the average person retired at 65 and died by age 77. Now, people are retiring at 62 and living to 82. If you and your spouse are still alive at age 65, there is a 25 percent chance that one of you will live to age 95. A conservative and thorough retirement plan must take into account both inflation and this increase in life expectancy.

Some more complex questions that retirees don’t spend enough time studying are:

  • Should I take Social Security early, on time or late?
  • Should I take my pension as a lump sum? If not, should I take benefits now or later? Should I add the spousal survivor option?
  • Should I rollover my 401(k) plan?
  • Do I need long-term care insurance?
  • At the start of retirement, should I take money from my individual retirement account (IRA), Roth IRA or joint investment account first?
  • What should be my overall asset allocation? How should it change throughout my retirement?

Unfortunately, there is not a one-size-fits-all answer to these questions. The biggest mistake is not realizing that these questions should be asked.

For most retirees, their largest source of retirement income will come from their investment portfolio of stocks and bonds. As we saw in 2000-02, this can be where do-it-yourself investors are their own worst enemies. As people near retirement, the cost of mistakes gets higher and higher, since it is during this period that portfolios are at their largest. A costly investment mistake can cause you to delay retirement and curtail your spending.

Making the assumption that investing in a variety of mutual funds ensures the best return can also be a mistake. Most mutual fund managers must stay invested in stocks, regardless of what the market does. In an ideal situation, an investor has someone who truly acts in their best interests and advises them when a divestment in stocks makes the most sense.

Most mutual funds have high fees, poor long-term performance and offer no other services. You may be relying on the mutual fund manager to sell stocks when their mandate is to always stay fully invested. Due to the poor disclosure of mutual fund holdings, you can never be sure what investments you hold until after the end of each quarter. You certainly can’t speak with the mutual fund manager about their opinion on your overall asset allocation or assistance in answering the list of questions above.

The upside of these questions, of course, is that there is always an answer, and it’s never too late to take control of your portfolio.

However, if baby boomers don’t consider the ramifications of improperly managing their retirement investments, they run the risk of many sleepless nights worrying about their money. In my book, that is not a successful retirement.

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