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By Christine Benz | 11-17-2010 01:05 PM

Identifying Behavioral Mistakes in Retirement

Morningstar's Christine Benz and MarketWatch's Robert Powell discuss managing fear and greed, considering balance sheet and cash flow, and purchasing annuities in retirement.

Christine Benz: Hi. I am Christine Benz for Morningstar.com.

I'm here at the Financial Behavior in Retirement Summit. And I'm joined today by Bob Powell; Bob is a retirement specialist and columnist for MarketWatch.

Bob, thanks so much for being here.

Robert Powell: My pleasure, Christine.

Benz: So the thesis for this conference Bob, I think it's a really interesting one. It's about how investor behaviors intersect with retirement.

One topic, I'd like to cover with you today is, what are some of the common behavioral mistakes that retirees and pre-retirees make?

Powell: Well, I guess everything boils down to two, right which is fear and greed.

Benz: Right.

Powell: Right. So on the fear side, what happens a lot is, when people are planning for retirement and they take themselves through some sort of calculation to figure of how much they might need in retirement, and they learn that it is a seven-figure number. They are sort of scared into inertia. So the biggest thing is for them to get over this notion of that, I need to save X dollars for retirement or otherwise I won't have a standard of living.

The other is to say that I'm going to be greedy and try to invest my way out of all my problems. So I think people need to put those two behaviors on the side or at least recognize that they exist and sort of look at from a much more realistic and rational point of view.

Benz: Okay. So, what are some tips you would offer in terms of actually getting started on that investment plan for retirement?

Powell: So, everything boils down to two things, Christine, one is sort of the balance sheet that you have and then the other is the cash flow.

So people really need to take a look at what do they have set aside for retirement, what their expenses will be in retirement and then getting a sense of how those expenses might change during retirement, both the planned expenses, maybe it's utilities or other living expenses, and then maybe the unplanned expenses, which would be health care for instance, which is the biggest one, it's the biggest one of them all.

And I think once people get a sense of, do I have enough assets, financial capital to fund my spending, you can make some decisions about what you need to do; save more today, spend less today, delay retirement.

And one of the things I think that happens along the way is that people get overwhelmed by the complexity of it. So, people need to at least maybe take some base line numbers. So one of the things that we talk about is, do you have 10 times set aside in your 401(k) IRA, do you have 15 times your last year salary, do you have 20 times set aside, at least, a benchmark to get started.

Benz: So, what is your reasonable benchmark in terms of what you should have when you're starting retirement?

Powell: I think a good benchmark would be somewhere between 12 and 15 times set aside in your IRA. Now, one of the things that people need to do is to look at the big picture. Many people work in retirement from say age 65 to 70. So that might reduce the need. Oftentimes you have social security, now you can take it at 62 or 65 or delay it to 70, but that stream of payments represents an asset that you have. So I think if people look at all the assets they have including the human capital, they can come up with a X times number that they have set aside.

Benz: One other thing I want to touch on with you, Bob, is this whole income focus versus a total return approach, I'm sure you encounter a lot of pre-retirees and retirees who are very focused on earning that current income from their portfolio; they don't want to tap their principal. What do you say to people who are in that position?

Powell: Well, I think it's depending on if your bequest needs and depending on how much you have set aside. I think but for the vast majority of Americans you probably have to tap into your principal, and you probably need to do in a way that protects you against the sequence of returns that you're likely to face. So as we know in 2008 and 2001, lots of folks either retired and started withdrawing 4% of their money, and have they go back to the workforce or reduce their standard of living.

So I think what people need to start doing is to maybe balance the possibility of drawing not only principal and income, but maybe spreading their assets across other types of things like single premium, income annuities or perhaps variable annuities with guarantees or other things that can allow you to create an income stream, but also give you some upside potential should you do live long enough and need to have some assets that protect against inflation.

Benz: Right. So this is an another question, and it's a huge topic onto itself, but if you're sitting with an advisor and they are talking to you about an annuity what are some of the key questions you should ask that advisor?

Powell: Well, I guess a lot of the questions have to do, some of them have to do, with the commissions, right? Because a lot of times annuities are sold and not bought, and oftentimes people don't know what they're buying, and these are very complicated products.

There are step-ups; there are penalties in charges for early withdrawals. There is the notion of what am I buying. So today annuities come in maybe in three flavors, right. There is a guarantee withdrawal benefit and guaranteed accumulation benefit and guaranteed income benefit.

So really getting understanding of what is that you're buying and understanding how that fits into the plan that they are creating. So many varieties of these things that it would be very hard for people to really know what they are buying.

I should caution also, I put together a list of questions that people should ask on MarketWatch, and the one comment that I got back from someone who is very knowledgeable about annuities is most advisors won't be able to answer these questions and then most people who hear the answers may not be able to understand them. So really, really take your time before you buy an annuity.

Benz: Okay. Well, Bob that's great advice. Thanks for being here with us today.

Powell: Thanks, so much. I appreciate it.

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