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July 1, 2010 Thursday 07:31 AM EST
SECTION: PERSONAL FINANCE; Retirement
LENGTH: 661 words
HEADLINE: Retirement Saving: Don’t Go With Your Gut
BYLINE: Joe Mont
BOSTON (TheStreet) — In the struggle to prepare Americans for retirement, government officials have focused on strategies such as automatic enrollment and products like annuities. Allianz , a global financial services company, took a different approach when the Department of Labor reached out to the public for guidance.Allianz rounded up a team of behavioral finance experts to consider the role psychology in planning for retirement. Leading that effort was Shlomo Benartzi, co-founder of the Behavioral Finance Forum, a collective of prominent academics and financial institutions. Last month, the results of that effort were released in a report that was based on interviews with top psychologists, consumer behavior experts and behavioral economists. “The human element is vital to understanding how retirees manage – or mismanage – their savings and critical to designing better solutions and policies.” says Benartzi, who is also a professor at the University of California, Los Angeles.As companies shift from pensions to 401(k) plans, workers must make more investment decisions as they save for retirement. The study found that retirees often make long-term decisions based on recent stock market performance, a dangerous strategy given that some of these decisions are irreversible.Many retirees fail to calculate their potential expenses in retirement, spending too much during the early years and leaving too little for later. This can be especially damaging for women. Older women see a 47% drop in income following the death of their husbands and, as a result, about one in five widows ends up in poverty.Post-retirement decisions are also frequently made amid increasing physical and mental deterioration. The report cites research by David Laibson, an economics professor at Harvard University, who estimates that half of people in their 80s suffer from dementia or cognitive impairment that’s severe enough to impair their ability to make sound decisions.Perception is also an obstacle. In the report, Jeffrey Brown, a professor at the University of Illinois, refers to the so-called “70% rule,” which advises people to plan on spending 70% of their current income during their retirement. This simple rule has become popular among financial planners and their clients. But when the concept is reframed as the “30% rule,” focusing on the expenditures eliminated, most people view it as unpalatable, even though the guidelines are identical.Many retirees, or those winding down their full-time careers, fail to understand the full impact of inflation, Benartzi says. An inflation rate of 3% compounded over 10 years can erode purchasing power by 25%. Compounded over 20 years, a 3% inflation rate can reduce purchasing power by nearly 50%. Retirees can fail to recognize the extent to which the purchasing power of future payouts designated in nominal dollars will be diminished, leaving them with insufficient funds to maintain their lifestyle or pay for medical services. With the average length of retirement at approximately 20 years, this possibility is likely.Benartzi thinks that many of the longstanding “rules” of post-retirement planning need to be reconsidered in a more personal way. For example, the accepted wisdom of spending 4% of your retirement savings each year is, perhaps, “not a good rule of thumb anymore.”He adds that not enough focus is placed on all aspects of retirement planning and that includes how much to spend and whether a lump sum distribution or reinvestment into a lifetime income stream, such as an annuity, is the best option for an individual.“You can’t just have an accumulation retirement plan, you also have to have a de-accumulation plan,” he says.— Reported by Joe Mont in Boston. Readers Also Like:>>Retirement Debate Focuses on Annuities>>Wealthy Americans Anxious About Retirement>>Tea Party Sympathizers Skewer 401(k) Proposal Get more stock ideas and investing advice on our sister site, Stockpickr.com.
LOAD-DATE: July 2, 2010