Most people have a retirement date in mind, but many haven't actually crunched the numbers to figure out if they can make that date work. A few simple steps will provide you with the information you need to make an informed decision on retirement. Importantly, you can diagnose any issues early so that you won't get blindsided after it's already too late to fix them.
1. Review your retirement account allocation
Getting your investment allocation right is one of the best ways to optimize your retirement plan. Your time horizon is one of the most important factors in determining asset allocation, and it's not always something that investors consider.
As you approach retirement, you generally want to shift your allocation slowly toward larger bond exposure at the expense of equities. Equities are usually well suited for investment growth goals. Historically, stocks have delivered higher average returns than bonds. Stocks should do the heavy lifting in the early years of retirement saving, helping to maximize account values for later down the road, when you get into distribution years after you stop working.
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Stocks play an important role in any portfolio, but that role diminishes over time. Bonds become more important closer to retirement. With fewer years left until you cash out, growth takes a back seat to volatility management. Bear markets cause large short-term losses, even if a company is still delivering strong financial results. If you're too close to retirement when a bear market hits, you might not have time to recover. Investors need to protect themselves from that risk by increasing their bond allocation as they approach retirement. This locks in gains and limits volatility.
The right proportion of stocks and bonds depends on several factors, but there are some time-tested methods to help you figure out your own personal needs. Investors who are using target date funds in their 401(k) are usually set in this regard, because the fund managers adjust their portfolio allocation over time. Once you've confirmed that your allocation matches your time horizon and risk tolerance, then it's best to remain calm as the market goes through its natural fluctuations -- you've already prepared your retirement account for that.
2. Check your Social Security statement
Social Security benefits are an essential part of many retirement plans. Social Security provides guaranteed monthly cash flows that often cover a large portion of basic needs, and most people pay into the program throughout their working lives without thinking twice about it. The average monthly benefit check is around $1,700 right now, which can go a long way for households that have their homes paid off.
However, most people envision a monthly lifestyle budget that's higher than that in retirement. Others might not be fortunate enough to meet their basic needs with that sort of payout. That's why it's so important to have a reliable estimate of the monthly cash flows that you'll be taking from Social Security benefits when you stop working. If you don't have a rough idea of what you can expect in benefits, then you probably don't have a solid overall plan.
Americans can check their status online so that they can calibrate their expectations. Knowing your current Social Security status provides important data so that you can make an informed decision. That's an important variable that lets you know how much supplementary income is required to meet your needs.
Knowing your Social Security status will aid you with numerous big decisions, such as your retirement age, saving rate, and investment allocation. Arm yourself with data, and don't let yourself be surprised when it's too late to change your circumstances.
3. Think about how much you'll need to save
The core of retirement planning is to ensure that you have the right amount of cash flow after you've stopped earning income from work. As a result, retirement planning can be broken down into two general phases: accumulation and distribution.
The accumulation is achieved by saving the right amount and investing it properly. That's how you maximize your nest egg when you stop working, and that part is intuitive for most investors. Distribution strategies are just as important, but most people don't think about those up front.
It's impossible to know exactly how much you'll need to meet retirement goals, especially if you're talking about planning across multiple decades of economic cycles, inflation, potential relocation, and evolving living standards. While it's tough to know the exact numbers, it's still important to understand the math behind retirement account distributions. When you stop working, you'll have to rely on the interest and dividends that are generated by your assets.
Financial planners have often used the 4% rule to forecast retirement account distributions. According to the rule, people can safely withdraw 4% of their total retirement savings each year without running out of money. That calculation was based on life expectancy and prevailing investment yields, both of which have been in flux across recent years. Throughout the 2010s, low interest rates and dividend yields combined with longer lifespans have caused many advisors to revise the 4% rule to a lower number.
Ultimately, you need to keep in mind a target monthly income rate, and save enough to produce that income. Social Security should get you at least part of the way there, and any other income, such as a pension, can play a huge role, too. Anything above that needs to be covered by assets. Using the 4% rule, someone receiving the average $1,700 Social Security benefit would need around $1 million in invested assets to push their total monthly retirement cash flow to $5,000.
Understanding the math and theory behind retirement account distributions is another really important step in goal setting. You can't really know when you're able to retire without considering this information first.
