Here’s something you already know: the world is a pretty crazy place right now. Of high inflation and rising interest rates to major market swings, the current economic uncertainty goes beyond anything we’ve seen since the 2008 financial crisis – and perhaps even before that.
Yet aside from the immediate impact on the cost of living, what does all this tough economic weather mean for your retirement plans? And more importantly, how can you protect your precious nest egg from the worst of its effects?
Test your portfolio under stress
The best place to start is to use financial planning software to determine what a period of no or weak growth may mean for your retirement fund. Ideally, it should be something a bit more robust than the freeware on the internet. Instead, you want enough “bells and whistles” to allow you to play around with different variables and really understand their potential consequences. (A qualified financial advisor can help you identify the best software to use. I like e-money advisor (opens in a new tab).)
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These variables should look like:
- What if we see inflation at 6% for a decade?
- What happens if I lose 20% of the value of my portfolio over the next three years?
- What if my annual rate of return at retirement is 5% and not 7%?
By stress test your portfolio against these scenarios, you can determine if there is a gap between your projected income and the level of income needed to fund your expected lifestyle in retirement, and if so, how big that gap is. Knowing this will then help you decide what actions to take to help close it.
Maximize your savings options
Which brings us to the second step: take advantage of all possible savings vehicles. For example, while most people participate in a 401(k), far fewer tend to be familiar with a cash balance plan. This is a type of tax-deferred defined benefit that allows you to invest a certain percentage of your income each year in addition to whatever you put into your 401(k).
Adding one to your portfolio is therefore a great way to build up your retirement kitty. In fact, if you’re in your early 50s, having a cash balance plan can mean the difference between saving $67,500 a year with a 401(k) and profit sharing and saving $258,500 — all on a tax-deductible basis (this would be a cash balance plan overlaid on a 401(k) with profit sharing). Accumulated over a decade or more, it’s a very good boost for your retirement fund!
Divide your nest egg
There are two types of expenses that define your retirement lifestyle: fixed and variable. Fixed expenses include unavoidable costs that you incur year after year, with little or no control over when you pay them. Things like your mortgage, utilities, property taxes, even your kids’ tuition.
Because these expenses tend to be non-negotiable, you should dedicate a specific portion of your retirement portfolio to cover them – which is the most predictable. income investmentssuch as municipal and government bonds, structured notes and annuities, come into play. These offer a stable rate of return, or guaranteed income in the case of annuities, so they can be tied directly to your fixed expenses. Resist the temptation to overcorrect by investing your entire fund in fixed income vehicles. Otherwise, you risk getting to a point where inflation exceeds your rate of expansion, making you worse off.
Variable expenses, on the other hand, are lifestyle costs over which you have some control, such as vacations, entertainment, and travel. These should be funded from a separate part of your portfolio to prevent them eating into the money you need for your fixed expenses, normally by selling stocks or dipping into your retirement fund when the time is right without ( hopefully!) sell at a loss or incur substantial costs.
Note, by the way, that some costs may appear in both expense categories. For example, your medical premiums are a fixed expense, but any costs you or a family member incur due to ill health or injury should ideally be covered as variable expenses.
Be ready for anything
No matter what stage of your career you’re at, it’s perfectly understandable for you to worry about how economic uncertainty like this could impact your ability to live the lifestyle you want. after completing your work. Yet the worst thing you can do is stick your head in the sand and hope for the best.
Of course, none of us can control how long this current storm will last or accurately predict when the next might hit. But by monitoring your rate of return against planned expenses, taking full advantage of all savings vehicles, and getting the right balance between fixed-income and variable-income investments, you’ll give yourself the best chance of succeeding with your wallet and your retirement. planes intact.