Do you know what box you checked when you signed up for your 401k or 403b or 529 plan? Pick something that sounded good, like “fixed income” or “cash max” or whatever? Guess what?

Wrong. You should give some serious thought to how you’re allocating that retirement fund, because for many people it will be the biggest investment you’ll ever make, except for your house, and we all know there have been a few problems with that investment, no?

Many of these plans have a terrible set of choices. I don’t know how employees let companies get away with offering them only Lord Putheimer funds or some other combo crap of high commission, low performance load mutual funds. I mean, pick up any newspaper and you’ll see an infinite number of recommendations to avoid these turkeys. But then, nobody reads anymore. If this describes the offerings of your company, it’s time to start “encouraging” a better choice of funds. It’s your money and your future, not the company’s.

But, let’s say your 401-403-529 does indeed offer some decent companies—Fidelity maybe, or T. Rowe Price, or if you’re really working at the right place, maybe they’ll even offer Vanguard. Should you pick the Target Date fund that most closely resembles when you hope to retire (or when your kid starts college), or should you hand pick specific funds? Here’s what you should consider:

• What’s in the proposed fund? What mix of stocks, bonds, and other investments does it offer? Mostly active funds or passive funds? Are you comfortable with 90% stocks, or would you sleep better with a 60/40 mix? You have to be comfortable with the risk, no matter what your actual age. On the other hand, I see many young people who watched their parents’ retirement funds evaporate and are more conservative than is reasonable.
• How much money do you have in it? If you are just starting out, investing in something diversified is important, and maybe difficult to achieve with a small amount of money. However, if there are six figures in that account, you may want to choose, or get help choosing your own diversification.
• How much time and knowledge do you have? Will you take the time to compare the target fund’s results to your own proposed portfolio selection? This can be difficult because many target funds don’t have a really long track record. Of course, historical performance is no guarantee of future results, but what else do we have?
• Is there a management premium? Check out how management fees are charged—does the fund charge an extra management fee on top of all the management fees in the individual funds? Is it reasonable? Could you invest in a reasonable selection of stock/bond/alternative funds individually for less total management costs? Ask for a Morningstar sheet on the target date fund and take a look at it compared to individual funds (individual bond funds and stock funds should be very low; international funds somewhat higher). Note that management fees are different from commissions or loads—management fees are what keep the lights on at Fidelity, Vanguard or whatever. They are deducted from the return you actually see deposited in your account. You’ll never actually see them, except as to how they affect your returns. Which can be a lot of leakage, depending on the fund and the fund company—another reason for passively managed funds with no “star” managers.
• How does it fit in with the rest of your portfolio? If you have a “rest of…” that is. It is quite difficult to do an accurate asset allocation profile with a target date fund in the mix. As an estimate, you or your financial planner can break the fund into percent categories, but it’s not easy. Also, if you have significant investment assets, you should be considering asset “location” as well—things that generate interest in non-tax accounts, things that generate capital gains in taxable accounts, internationals in taxable accounts, as a ROUGH guide—your own investment picture may vary. Target date funds give you less control.

Now, don’t use any of this as an excuse to stop contributing. If you get an employer match, you’ve probably already gotten a better “return” than the market is offering. Then, there’s the tax benefit of salary reduction. As with all wealth building, first HOLD ON to your money, then figure out the best way to invest. If your 401k forces you to save, that may be the best investment of all.

 

If you’ve read even three how-to-retire articles in the last decade, you’ve seen the percent-of-salary argument. It goes something like this: you need “x%” of your current salary to retire. Usually that number is 80%, and then the article proceeds to argue why that isn’t right and how you can, basically, never retire.

So, what do I have to say differently about the subject? Well, it depends—it depends on who you are, what your current level of spending is, what your current expense picture looks like.  Like all real life financial planning, it’s a highly individualized process that has to take into account an awful lot of variables. But let me give you a dozen considerations so you have some new things to worry about late at night:

1.  Are you currently a saver or a spender?

If you are spending everything you make, you’re probably going to need 100% of your current income in retirement. On the other hand, if you’re already saving at least 20% of your income, maxing out your 401(k) or SEP, or have a ton of unspent cash in your savings account, you can subtract that percentage from your future needs—it’s going to be a hard habit for you to break, but you really can ease up on the saving. This IS what you’ve been saving for!

 2. How much do you spend on work related expenses?

Do you drive downtown every day and pay for parking? Are you in Armani? Do you eat every lunch out and stop at Starbucks on the way in? Are you entertaining clients on a regular basis? Most of this you can cut back on in retirement. Figure out what you spend as a proportion of your income, and subtract that from your retirement needs.

 On the other hand, if you already work at home, or go to work in jeans and brown bag it, or take the bus, you’re not going to save anything in this category in retirement. So, back up to 100%.

 3. How many cars are you supporting?

Each car you live without saves you thousands—both in repairs and maintenance, and in insurance, capital for future purchases, or lease/loan payments. Try out this calculator to see what it’s really costing you.  Again, figure any reductions as a percentage of your yearly income and subtract from your 100%.

 4. How many people are you supporting?

Any chance your kids might move back in with you (or are still there)? Is there anyone in your family with disabilities that might make them dependent on you? Elderly parents? Based on my own experience, you might be amazed at how much it can cost you to eat at a hospital for weeks (when you’re the caretaker). Or hire a “medicar” to get your elderly parent to the doctor. Or how much the grocery and electricity bills can go up when the kids move back.

 5. How’s your health?

Probably fine right now, but that can change big time in the blink of an eye. Whatever you’ve calculated as your potential retirement income (investment withdrawal, Social Security, pensions), is it enough to support $250 a day (that’s $7,500 per month) for, say, 4-7 years at a nursing home? Add maybe another $1,000 per month for “extras” that aren’t included in the nursing home fee, and aren’t paid by insurance. Think you’ll stay home instead? If you need round-the-clock care, it’s even more expensive, which is the secret to why a lot of people ultimately choose nursing homes. At least in the Chicago area, that $250/day isn’t even the nicest nursing homes. If your nest egg for retirement is less than $2 million, you must consider long term care insurance. And maybe start an HSA savings account, if you’re eligible, to pay for the donut hole in drug coverage. Retirement planning, and the amounts needed, must take into account the need for breathtakingly expensive long term care, and the burden of caring for you that loved ones might undertake. And you thought college was expensive!

 6. How much debt will you have?

Is your house paid off? Whether it should be is a tough question that I’ll take up in other blog posts. If you go into retirement with a house payment, though, you’ll require enough income to continue to make the payment. If you rent, you’re going to need to plan that that cost will go up over time.

 7. Have you figured in inflation?

 If you’ve paid off the mortgage, do you have sufficient investment cash to continue the likely escalation in property taxes, utilities and a fund for major home repairs? For example, if you’re retired for 30 years, you’re probably going to need to reroof at some point during that period. A rule of thumb I’ve seen is to budget 1% of the value of your house for home repairs every year. In my case, it’s been at least that much and in some years, much more. But take 1% of your house’s value, and add it to your retirement budget—otherwise, a re-roof or a new driveway can be a budget buster that requires you to break into your retirement principal or skip a lot of vacations.

 8. How much do you do yourself?

Cleaning service? Landscaper? Even if you think you might handle some of this in retirement, your health may not allow it at some point. Try to make a guess at these costs.

 9. How cutting edge are you?

Are you first with the newest or are you still driving a coal-fired computer? How early you buy and how quickly you discard can adjust your number up or down, particularly if you change your habits in retirement (in either direction).

 10. How much do you want to gift?

Taking a couple of grandkids to lunch and the ballet, or a week in Disneyland, or buying a new set of tires for a child who’s broke can quickly add up (thanks, Mom & Dad). If you’re anywhere near affluent enough to consider doing these things, you’re going to do them. Make them part of your budget.

11. Do you belong to an organization or a church?

Will your donations be time and effort or cash? Generous cash givers may want to adjust donations down in retirement, giving time instead, or adjust up, if supporting an organization is one of the goals you’d always planned for in retirement. Also, I’ve found as I get older that neediness tugs at my heart strings even harder than when I was in my twenties.

12. Do you plan to move?

To a cheaper place? A different area? Can you wait out the market to sell your house? Have you calculated closing costs, travel to a new location, the possibility of rental costs between purchases, or the cost of packing and moving itself?

 So now, is it 80%? or 50%? or 100%? Thinking maybe you’ll work a little longer?