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Overcome the Misconceptions and Chart Your Course
THE MISCONCEPTION: YOU'RE ALREADY PREPARED TO RETIRE
According to the National Retirement Risk Index, millions of Americans believe they are successfully headed down the road toward retirement, but their self- assessments are dead wrong. These Americans come in all types and stripes, but for the purposes of an example, let's look at the story of Wisconsin Rick. (This example is fictitious but based on reality.)
Wisconsin Rick sold his electrical-supplies company five years ago, ending up with $8 million in liquid assets. He placed over 90 percent of his portfolio in high-risk growth stocks. Why such a gamble? Simply because Rick has a high risk tolerance and is a confident man. At age 47, he is a mover and shaker around town, plays golf every day at a posh country club, owns a lovely cabin overlooking Lake Michigan, where he enjoys his 58-foot yacht, and eats at the finest restaurants. He's a pretty smart guy, and he made a lot of money selling electrical supplies, primarily cords and adapters. As with many characters like Rick, he is occasionally correct but never in doubt.
Three different times, however, one or more of his financial advisers or friends warned him to diversify his portfolio. His accountant brought it up first, but Rick rebuffed him. His attorney, a golf buddy, also mentioned diversification, but the discussion never went any further. His investment adviser then suggested that Rick might want to consider some bonds and other more conservative securities, but Rick reacted with even more blind confidence, saying, "These high-risk stocks will continue to double every year."
When his net worth dropped from $8 million to $4 million only two years after Rick sold his company, his advisers warned him once again. Later, when that $4 million dropped to $2 million, his accountant actually begged him to consider a change. Though he had no financial plan, Rick insisted the stocks would go right back up. He did not know his final destination or why he took great risks with his portfolio, but he trusted himself more than the professionals who regularly dealt with the market.
Today, Rick has $300,000 in liquid assets, but he is effectively bankrupt, as creditors have placed liens on his remaining money. He sold his yacht and his cabin for a loss. His 5,000-square-foot home has a second mortgage. He now plays golf at the municipal course.
You Know What Happens When You Assume
Rick is the poster child for presumption. Although he was successful at making large amounts of money with his business, he never took the time to develop a strategic plan for this money. Rick could have garnered the counsel of professionals regarding how to develop a plan for his financial future and how to invest his assets. Instead, he relied on his gut instincts, which were entirely wrong. Rick knew he had a lot of money in his home equity, and he presumed the housing market would always keep skyrocketing. He had no provisions in his portfolio for the financial meltdown that wiped out his stocks.
A Real Rick
The Wall Street Journal provides a true story similar to Rick's. Michael Donahue made his fortune during the dot-com bubble of the 1990s. Donahue watched his personal stock value rise to $448 million a few months after his business-to-business company, InterWorld Corp., made its initial public offering (IPO) in 1999. Until then, the 36-year-old was making $200,000 a year.
What to do? Donahue bought a $9.6 million home in Palm Beach, Florida. So that he and his wife could enjoy the home while working out of New York, he acquired a private jet. A polo enthusiast, he thought nothing about six-figure contributions to the local polo club in Palm Beach. Donahue had joined that very exclusive group in the world known as the centimillionaire club ($100 million net worth or more). But not too long after he had acquired that wealth, the dot- com bubble burst, and Donahue's $448 million fortune plunged to $12.6 million.
Donahue put his house up on the market. "Going up was easy," he said. "But when it starts going down, no one wants to talk to you."
Unlike many others who joined the centimillionaire club thanks to the Internet boom, Donahue saw his stock stay sky-high long enough that he could sell his shares after the lockup period, the few months' waiting time before owners of IPO stock are allowed to sell it. Unfortunately, Donahue didn't take advantage of that freedom, since the sale of company stock by a top executive creates bad publicity, which he wanted to avoid. Instead, Donahue took out a $14 million loan against his nearly half-a-billion-dollar stock valuation. When the stock dropped, his company stock assets were worth less than the amount he owed.
Donahue had assumed his financial future would be bright, just as Rick was confident that his shoot-from-the-hip strategy would work just fine. If you were able to ask them before financial disaster struck, they would have told you, "Sure, I can retire. No problem."
THE TRUTH: RECENT TRENDS MAKE IT MUCH MORE DIFFICULT TO RETIRE
Michael Donahue assumed. Wisconsin Rick assumed. We all do it to a certain degree. For millions of Americans like Rick and Michael, financial freedom appears to be squarely on the horizon, and the question of retirement needs no deliberation, no professional assistance, and no strategic planning. In reality, the question of retirement requires all three. If Wisconsin Rick had been made more aware of the financial landscape regarding retirement, who knows? Perhaps he would have been more open to advice. Maybe his future would look much better today.
What follows are nine trends or developments to keep in mind in regards to your retirement. Unfortunately, it is too late to share them with Michael Donahue and Wisconsin Rick.
1. Changes in Social Security
Though Strategy #2 will make it clear that Social Security will indeed be there for you when you retire, it is likely to be less than you expected. Here's why:
* The normal retirement age is gradually being increased from 65 to 67. For those who choose to retire at age 62 or 65, a significant portion of the expected check will be missing.
* Through the 2010s, Medicare Part B premiums, subtracted directly from your Social Security check, are scheduled to increase from 9.4 percent to 11.8 percent of your Social Security benefit.
* For those at a high-income level who pay taxes on Social Security benefits in retirement, the levels of taxation will increase with the rate of inflation.
Social Security only replaces 43 percent of income for low-wage workers. The percentage is lower for high-wage employees. That low number is expected to drop even further to 39 percent when the Full Retirement Age process (the increase from age 65 to 67) is completed.
2. The Decline of Traditional Pensions
In the 1980s, traditional company pension plans, not IRAs or 401(k) plans, were the primary source of private pension coverage. Because the choices were fewer and the ability to get money early was more difficult (or impossible), workers tended to have more money awaiting them in the future. The employer enrolled the worker, made the contributions, and invested the money. Typically, the only available decision for the employee was the age at which to retire.
According to a study by the University of Michigan, one-third of all households end up having no pension coverage at all. This estimate is actually a conservative one, compared with the 50 percent figure cited by studies tha
Excerpted from YOUR STRONGER FINANCIAL FUTURE by MIKE EGAN. Copyright © 2012 by Michael J. Egan. Excerpted by permission of The McGraw-Hill Companies, Inc..
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STRATEGY #1 Overcome the Misconceptions and Chart Your Course....................
STRATEGY #2 Develop an Overall Financial Plan of Which Social Security Is Only One Part..........
STRATEGY #3 Identify the Inflation-Adjusted Amount You Need at Retirement....................
STRATEGY #4 Retain a Licensed Financial Professional Who Deals with Wall Street..................
STRATEGY #5 Maintain Your Own Personal Bailout Fund....................
STRATEGY #6 Rather than Accruing Debt, Accumulate Savings....................
STRATEGY #7 Utilize Annuities and Other Strategies to Account for Longevity and Health Care......
STRATEGY #8 Plan Your Legacy Through Children and Charity....................