FOOL ON THE HILL

Three Roadblocks to Retirement

Americans aren't doing enough to prepare for retirement. One reason: Investors, confounded by all the choices, feel they must examine all their options. The result: "analysis paralysis," whereby the quest to know everything delays someone from just doing something. However, there are basic steps investors can take now to get their retirement saving in gear while they look for the "perfect plan."

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By Robert Brokamp (TMF Bro)
November 5, 2002

Raise your hand if there's something you can do to improve your prospects for retirement. If the results of a couple of studies are any indication, a lot of people out there in Fool-land should have their hands held high. According to Retirement Insecurity: The Income Shortfalls Awaiting the Soon-to-Retire:

  • From 1989 to 1998, the percentage of near-retirees who will not be able to replace half of their pre-retirement income rose from 29.9% to 42.5%.

  • Almost one-fifth (18.5%) will live below the poverty level, up from 17.2% in 1989.

  • Retirement wealth declined 11% from 1983 to 1998 for households at the median.

Then there's this news from the Retirement Confidence Survey (RCS): Almost half of all working Americans (47%) have saved less than $50,000 for retirement, and 15% haven't saved anything.

Sure, the problem might come down to plain, old procrastination and the inability to delay gratification. But I believe many of us are responsible, well-intentioned, golden-years-coveting workers who haven't saved enough for retirement because we're just not sure what to do. We get overwhelmed by all the choices available and decisions to be made, a condition known as "analysis paralysis."

We know we have to save for retirement. There might even be IRA enrollment forms in our "To Do" box right now, along with 401(k) forms, a book singing the praises of index funds, and an article claiming that indexing is dead. But, because we feel like we don't know enough to make a decision, or because we want to read just one more article before making an investment, the forms go unfilled, and the money goes unsaved.

Essentially, there are three decisions to be made about a retirement plan: how much to save; what account to choose; and where to invest the money. But these decisions can become roadblocks if someone feels she needs to know everything before doing something.

So to help you conquer your analysis paralysis, here are all the answers you need to get started on your retirement plan. Note that this doesn't get you off the hook for doing some real retirement planning. (Our Rule Your Retirement Online Seminar for near-retirees would be a great next step.) But taking these steps will definitely improve your retirement prospects.

Ready? Here goes:

Roadblock 1: How much to save?
Is saving $200 a month enough? Is $2,000 too little? Depending on where investors are along the retirement-planning process, and which sources they consult, they may be told they have to deposit the equivalent of their mortgage each month in a retirement account. When confronted with such large numbers, people often do something extraordinary: They do nothing. "I can't possibly save that much," they say, "so I won't even bother."

Then there's the question of limited resources. After paying the mortgage, gassing up the minivan, compensating the child-care provider, and ordering an Outback Bloomin' Onion as an appetizer to the Prime Minister's Prime Rib, there's not much left for the 401(k). Inflation-adjusted median household income has increased 31.6% since 1967 (the first year household income was recorded), but the paycheck is being divided among more and bigger goods and services. (And who worried about retirement back then, anyhow? Retirees had Social Security and the company pension -- 401(k)s and IRAs didn't even exist in the '60s, not to mention cable TV, personal computers, cell phones, and other depositories of our disposable income.)

The quick solution: Save 5% of your pretax salary. Get it out of your hands by having the money taken out of your paycheck or checking account automatically. Starting with 5% should mitigate the effects of "savings shock," but you should work up to saving 10% of your pretax income... at least. If you're within a decade of retirement, can you save 15% or 20%?

Roadblock 2: Where to put the savings?
We have a lot of choices for our retirement money: the retirement plan at work, a traditional IRA, a Roth IRA, an annuity, a regular brokerage account, or even the house (in the form of a paid-off mortgage).

Though it's important to have options, and we like to have choices, too many choices might be why people find retirement planning daunting. Studies have shown that more choices lead to fewer decisions.

For example, Sheena Iyengar of Columbia University and Mark Lepper of Stanford University set up booths in a grocery store displaying either six or 24 flavors of jam. The results showed that while more shoppers stopped at the booth with 24 flavors, those who stopped at the six-flavor booth were 10 times more likely to buy something. Studies involving gourmet chocolates and optional school essay assignments found similar results.

The quick solution: If your employer matches your contributions to the company's retirement plan, start there. If there's no match, or you've contributed enough to get full benefit of the employer match, then contribute to a Roth IRA, if you're eligible. The traditional IRA might be better for those in a much higher tax bracket now than they will be in retirement. Fiddle with these calculators to see if you're eligible for a Roth, and if a traditional IRA would be better for you.

Roadblock 3: Where to invest the savings?
This may be the biggest problem right now. Faith in the stock market -- both from a performance and regulatory standpoint -- has been severely weakened. But interest rates on fixed-income investments are paltry. And isn't the bond market due for a correction?

And then there's the expanding number of funds in 401(k) plans. What percentage of contributions should go in the large-cap domestic equity fund, the small-cap emerging markets fund, the intermediate-term bond fund, and the exploitation of vices fund that invests in companies dealing in tobacco, alcohol, pornography, and professional football (which are inextricably linked, judging from recent beer commercials).

The quick solution: Choose the investments you're comfortable with. If the thought of investing in the stock market gives you indigestion, then don't do it. You can go with the bond fund choice (though bond funds can lose value, too) or the money market/stable value option. It is far more important that you begin saving than that you find the perfect investment (which, by the way, doesn't exist). Then, after more research, you can move into riskier investments, which, over the long term, should provide greater returns.

Whatever you do, just do something. A mediocre plan will always beat an outstanding plan that never became an action.

Robert Brokamp's retirement plan relies on a 401(k), a Roth IRA, and index funds. Could it be more boring? The Motley Fool is investors writing for investors.