There is no shortage of advice out there about money and retirement. Some of this advice is timeless—but some of it should go away and never come back. Certain tips are helpful early in life, but no longer apply once you’re ready to retire. Breaking with behaviors that have served you well in the past is often harder than you’d think.
“Keep a 6- to 12-Month Emergency Fund.”
Conventional wisdom says that if you and your spouse are both working, you need to keep a 6‑month cash reserve, but if you’re single or the sole breadwinner, you should keep a 12-month reserve. This rule of thumb makes perfect sense for someone who is still working, but once you’ve reached financial independence, it doesn’t really make sense anymore. That’s because, ideally, part of your investment portfolio will be invested in accounts that you can access with relative ease and minimal tax impact. It is very common to see people getting ready to retire with a 6‑figure cash balance. For most people, that’s too much cash to have sitting around earning very little, if anything. In most cases, if one of our clients tells us they need money, we can typically get it to their checking account in about a week (sometimes faster in an emergency circumstance).
“After you retire, you should just live off of the income from your portfolio.”
This is one of those recommendations that many Baby Boomers got from their parents when they retired. When interest rates were 7% (or 17% like they were in the early ‘80s), just spending the interest seemed like a reasonable strategy for someone who grew up during the Great Depression. But even back then, it wasn’t ideal. The unintended consequence of following this advice can lead to higher allocations to bonds and slower-growing dividend payers and lower allocations to investments that are more growth-oriented. A better strategy for most people is to spend a combination of principal and income that is capped to stay below 4% of their portfolio’s value. The additional exposure to growth-oriented investments can provide better protection against inflation than bonds or slow-growing dividend payers.
“You should have your age in bonds.”
The recommendation that I’ve heard many times over is that the percentage of your portfolio that’s invested in bonds should match your age. For example, a 70-year-old should have 70% of their portfolio in bonds, while a 25-year-old should have 25% of their portfolio in bonds. This is another piece of advice that was passed down from folks who lived through the Great Depression and had an understandable distrust of the stock market. For most people today, this would not be advisable and could leave them with a rate of return that might not accomplish their retirement goals. Most investors should strive to have as much in stocks as they can and still sleep at night. Being able to sleep at night is a highly subjective measure, which is why it’s sometimes appropriate for two retirees in seemingly similar financial circumstances to sometimes have wildly different target stock allocations.
“I’m going to start taking Social Security at age 65.”
I suspect this advice was also passed down from Boomers’ parents. For anyone born in 1937 or earlier, their Full Retirement Age was age 65. In 1983, a law was passed to gradually increase the Full Retirement Age to age 67 (it increases slightly depending on what year you were born, but is capped at 67 to anyone born in 1960 or later). Age 65 is the age that most people become eligible for Medicare, and Medicare Part B premiums are usually deducted from their Social Security payments. Because of this, I think people often assume that the decisions of when to start Social Security and when to enroll in Medicare are the same, but they are two separate decisions that need to be considered. You can claim Social Security as early as age 62, but for each month that you wait, your potential benefit increases until the month you turn 70. Full Retirement Age is most significant because if you turn on your benefits before then and you are still working, your benefits will be reduced and then get added back once you do reach your Full Retirement Age. If someone works enough, it could eliminate their Social Security benefit until they get to their Full Retirement Age. For someone contemplating taking their benefits at age 62, by delaying until age 70, their monthly benefit will be roughly 70% higher (however, they would have missed out on the preceding eight years of payments). When to start Medicare is a decision that largely depends on whether you are still covered by your employer’s health insurance.
“I need to pay off my mortgage before I retire.”
This is one piece of advice that many people view as an “absolute” that I’d rather classify as an “it depends.” Many think that eliminating this monthly bill will reduce how much they need to save and spend in retirement. However, it’s worth considering that paying off your mortgage is a choice between investing and debt repayment, and this choice should not be taken for granted. For example, if you pay an extra $1,000 a month towards the principal on your mortgage, you’ve given up the opportunity to put that $1,000 a month into your 401(k) or another investment account. While the rate of return on your investments is not guaranteed, over long periods of time, the return on a diversified portfolio of stocks and bonds has generally exceeded the current interest rates on mortgages (currently about 3% on a 30-year mortgage). If we assume that you have a $300,000, 30-year mortgage at 3% at age 60 and paid an extra $12,000 a year towards the principal, you would have paid off the loan by age 74.
But what if, instead, you just paid the required payment on the mortgage and invested that $12,000 a year into a portfolio averaging a 7% annual return? By age 74, your mortgage balance would be roughly $192,000, but the funds invested in your portfolio would be worth over $270,000. That means that with the required mortgage payments, you’d have paid down $108,000 of the principal on the mortgage—and $270,000 in your portfolio. In other words, if you pay down the mortgage faster, you will have paid down $300,000 of debt, but if you had invested the additional funds and just paid the regular payment on the mortgage you would have paid down/saved a combined $378,000. Debt can be used for good when time is on your side.
“You’ll spend 80% of your current income in retirement.”
I hear this advice in all kinds of publications: “Expect to spend 80% of your last year’s salary in retirement.” For many people, 80% will get them pretty close, but it depends on their plans and their situation. Some people plan to have very simple retirements and their expenses may be much less than 80% of their salary. Their idea of a good retirement is staying home and enjoying their free time around the house. If they listened to that 80% of income rule, they might find themselves working much longer than they ever needed to. For others, their idea of a good retirement involves vacations, second homes, and other activities that they didn’t have the time to enjoy while they were working.
For many of my clients, their last year of work is often one of the highest-earning years of their life. They frequently use that higher income to do a lot of renovations and home improvements to make sure that their house is the one that they want it to be for the rest of their life. Those expenses won’t occur every year, so why would you include them in projecting permanent ongoing needs?
Instead, sit down and make a budget. Plan what your lifestyle will look like and what things you may want to do differently now that you are no longer going to work every day. I know it’s no fun making a budget, but it could save you from either not saving enough for retirement or working longer than needed to accomplish your goals.
These misperceptions can end up costing a lot of money, and more importantly, years of your life working for someone else rather than pursuing your passions. While challenging the common wisdom is never easy, working with a professional can help you better understand your blind spots and create a retirement plan that supports your goals—even if it means breaking a few “rules” along the way