Educating Rico: Retirement

Retirement planning

TEXT OF STORY

Tess Vigeland: Retirement, you may've noticed, is a popular topic on this show. Not surprising -- one of main reasons we save and invest is to get ready for the golden years.

Still, our own Rico Gagliano figured he had a ways to go before he had to think much about retirement, but on this month's installment of our series "Educating Rico," father knows better.


Rico Gagliano: Hi. I'm Rico. And though I've spent the last few years learning the basics of personal finance, I'm older than you probably think. Like, I remember when this came out:

[Music:] Styx, "Come Sail Away"

I even remember liking it sincerely, as opposed to ironically like kids do nowadays. My Dad, on the other hand -- he remembers when this came out:

[Music:] Andrews Sisters, "Apple Blossom Time"

And he also remembers this:

Franklin D. Roosevelt: The only thing we have to fear is fear itself!

FDR telling America to buck up in the face of the Great Depression.

In other words, Dad's pretty old. In fact, he's about to retire at age 77. He's got a good nest egg of stocks and other investments in his TIAA-CREF account. Last December, I called him to talk about it.

Rico's Dad: Hello?

Rico: Hello father.

Rico's Dad: Hello son.

Rico: So, you're retiring! So, when exactly are you planning to retire?

Rico's Dad: It looks like a year from now. End of '08.

Rico: How much do you have?

Rico's Dad: Well, at the moment... the stock market looks good today -- I suppose it'll dive next week. But, it's about $970,000.

Rico: Damn! Well, it seems good to me. How do you feel about it?

Rico's Dad: Well, I was thinking, when my father was alive, he would think "My God, you've become this monster-millionaire!" But, of course, I don't think that at all because I'm going to then be living on that and Social Security. That's it -- I don't have any outside stocks or anything. I don't know how to allocate it all...

Rico: Wait, it seems to me you've got basically a million dollars. If you put that in a money market account with an interest rate of 4 percent, you're going to make $40,000 a year off that without doing anything.

Rico's Dad: If I were to do that, roll it over completely, I'd have to pay taxes on that lump sum and then live after taxes. Even as we talk, everything is getting more expensive, you understand.

Rico: And I know that health care is an issue, although you're very healthy.

Rico's Dad: But anything catastrophic -- and I certainly know people to whom this has happened -- I could be wiped out.

Rico: You really think you could be wiped out?

Rico's Dad: Yes.

Rico: Alright, on a happier note, if I was able to tell you you'll be able to afford it, what would be the thing you would most like to do in your retirement?

Rico's Dad: Gee, I don't really have any crazy things I'd want to do.

Rico: See, this is the different between you and me. I'd take $100,000 and put it on red or black on roulette in Vegas.

Rico's Dad: Oh no! But that is because you were not a product of the depression, Rico. You came about in plush times.

Rico: You've spoiled us, old man!

Yes, "ha ha," we laughed. But remember, this was December.

Since then… Dad's lost $25,000 in the market slump. No big deal for a young'un, but a very big deal when you're about to start living off your portfolio. He may even stay in his job an extra year if the slump continues.

In other words: preparing a portfolio just before retirement is no laughing matter.

So, for some basic advice on how to do it, I've called upon investment manager Frank Armstrong. He's also author of the retirement planning book "Sink or Swim."

Rico: Welcome, Frank.

Frank Armstrong: Great to be here, thanks.

Rico: Let me ask you first of all: is a million dollars enough?

Armstrong: Depends on how much income you need. We've got a lot of studies that show you can safely withdraw 4 to 5 percent of that each year and expect to have it last 30-35 years.

Rico: So, you think my dad's in pretty good shape?

Armstrong: Well, if he tells me he needs $60-70,000 a year from that million, I'd get concerned.

Rico: Alright, well let's take a step back. Part of his retirement account is a defined benefit kind of thing, where he basically gets an annuity. That's like $300,000 of the account and the rest, he can allocate. Now, he's been losing money in the stock market. How should he allocate?

Armstrong: First of all, he's probably going to live for a very long time if he's in normal health. Inflation's not going to go away -- I mean, you're talking to a guy that remembers $1 gasoline, right?

Rico: Me too!

Armstrong: So anyway, inflation's not going to go away and he has to plan for that. So, he's got to put part of it into the market and keep enough of it liquid so that if the market has several bad years in a row, we can still meet his retirement income needs.

Rico: What kind of stuff would you be allocating into?

Armstrong: Well, let's say that he wanted to have $40,000 from his million-dollar account...

Rico: Per year?

Armstrong: Per year, right, and that we agreed to have at least 10 years of that income where we can get at it without any thought about what's happening to the market. So that would be $40,000 times 10 years, $400,000 into a very short-term, high quality bond fund and then the rest, you could allocate in a globally-diversified portfolio of high quality index funds. You index just about the entire world's economy.

Rico: It doesn't sound like it's that much different of a strategy than we advocate all the time on this show, which is index funds.

Armstrong: Our mantra in our office is low cost, low risk -- which means relative to the market -- and low tax exposure, and working backwards from that, the way we think you ought to go about it is either using index funds or exchange-traded funds.

Rico: Now here's the big question mark, of course, that gets throw into all this: how do you sort of strategize -- or can you strategize -- for what could be, potentially, a major illness?

Armstrong: It's a wild card. I personally own a long-term care policy. That's reasonably expensive, but it allows me to know that I can stay in my home with some dignity. That's part of the health care problem. The rest of it though, is under the government's control and all of us have concerns about it.

So there you have it. Some concrete advice: Plan on living off 5 percent of your retirement savings per year. Protect several years worth of that in a bond fund. Consider global index funds for the rest. And as for preparing for medical expenses, cross your fingers, because 75 years after the Great Depression, to paraphrase FDR:

Franklin D. Roosevelt: The only thing we have to fear is...

…a broken health care system.

In Los Angeles, I'm Rico Gagliano for Marketplace.

About the author

Rico Gagliano is the host of Dinner Party Download.

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