Seven Steps to Avoiding a Retirement Crisis

Every day in the newspaper there is another article that might worry those approaching retirement. For example, one might read about large companies unable to meet their pension obligations transferring these pensions to government receivership. Even venerable and financially sound corporations are moving from the defined benefit pension model to the more popular defined contribution options, such as 401(k) plans. Some speculate that returns in the stock market over the next 20 years will not match those we have seen over the past 20. In this environment, it is more important than ever for workers to take charge of their own retirement security.

The problem is that many people have not been doing so. A new report issued by the Employee Benefit Research Institute and underwritten by several finance companies found that many Americans are unprepared to meet the financial obligations of their own retirement and seem to have too optimistic a picture of their financial situation. Compounding this problem, many people also tend to underestimate how long they'll actually live and, thus, what will be required for a comfortable retirement.

At Morningstar, we don't want to engage in broad-based speculation on how this problem can be solved at the national level, but for those getting a late start in retirement planning, we do have some practical steps you can take to avoid having your own retirement crisis. In this week's column, we'll provide some general guidance for those looking to jump-start their retirement planning. In next week's article, we'll provide more specific portfolio-construction and asset-allocation guidance.

1. Take a Deep Breath and Examine Where You Are Right Now
Procrastination has perhaps made it tough to retire when you'd ideally like to, but don't make things any worse than they are. If you immediately begin taking steps to shore up your long-term financing, you'll not only be able to make up lost ground, but you'll feel better about your situation as well.

The essential first step is to look carefully into your financial situation and figure out how much--and what--you have now. A great starting point is to enter all of your current holdings (or update them) in Morningstar.com's Portfolio Manager tool. This will allow you access to Morningstar.com's many tools, such as Instant X-Ray, Stock Intersection, and X-Ray Interpreter, which will give you a good glimpse of where your portfolio currently stands.

2. Educate Yourself about Investing or Find a Financial Planner You Trust
If you find yourself planning for retirement late in the game, the next step is to educate yourself about the investment process. This does not have to involve years of study--leave that to others who obsess about finance--but a great place to begin is with a few essential books. For general books about investing, we like Andrew Tobias' The Only Investment Guide You'll Ever Need and The Wall Street Journal Guide to Money and Investing. If you're looking for a book specifically about mutual funds, check out the Morningstar Guide to Mutual Funds by my colleague Christine Benz. This book will show you how to select funds that will help you meet your retirement needs and construct a well-diversified and coherent portfolio. John Bogle, founder of the Vanguard Group and a pioneer in index investing, wrote another favorite, Bogle On Mutual Funds. Finally, for readers who are more finance-savvy, A Random Walk Down Wall Street by Princeton University professor Burton Malkiel is one of the best overviews of the investment world, detailing its history and theories, as well as providing practical suggestions.

If you're someone who has no time or aptitude for financial planning, or if the prospect of creating a retirement plan by yourself is too daunting, you may want to consider finding a financial planner you can trust. While Morningstar is a leading resource for do-it-yourself investors, we certainly realize that some people require a planner's help, and if you go this route, the sooner you seek help with retirement planning the better off you'll be.

3. Put Your Retirement Security Ahead of Other Considerations
If you find yourself getting a late start on retirement planning, you'll need to prioritize your own retirement security over other potential financial commitments, such as your children's educational expenses or any inheritance you hope to leave them. It's natural to want to do as much as you can for those you care about, but if you have not adequately prepared for retirement, it is very important that you focus on remedying this situation first. Your children will likely be able to find alternative ways of financing college, and the alternative (should you underprepare for a potentially long and costly retirement) might be that they support you financially as you age. With the rising cost of medical care and increasing longevity, this could prove a greater financial burden to children than requiring them to fund their own educations. A similar point can be made regarding the inheritance you may want to leave, as clearly it would be better for everyone involved if you could provide yourself a decent retirement, even if it means not leaving money behind.

4. Get Your Living Expenses under Control
One of the best ways to free up money for savings and investment is to lower your expenses and then divert the proceeds into your retirement-savings account. Individuals' appetites for goods have a remarkable way of expanding to fit their means, or, as is more often the case in the U.S. today, they take on debt to purchase what is well beyond them. Look through this past quarter's credit card and bank statements to find places to cut expenses, because tightening your fiscal belt can be an excellent way to raise money quickly. For instance, cutting back on dining out or hanging on to your old car for a few more years before replacing it are simple ways to reduce costs so you'll have more to invest.

5. Get out of Debt, Particularly High-Interest Obligations
This seems like an obvious point, but at a time when the average American household is at near-record levels of indebtedness, it seems worth repeating: Paying off debt should be one of the first steps in your financial plan. That's because paying a high rate to service debt easily negates the return you might earn on any money that you are able to invest. While mortgage, home equity, auto, and student-loan debts should be aggressively paid down, the most pernicious form of debt is high-interest credit card obligations. The average U.S. household had more than $9,300 in revolving credit card debt in 2004, and if we assume many of these cards charge 15%-20% a year in interest, it's not hard to see how they cut into one's ability to save. Consolidate with a single credit card with a low rate or take out a lower-interest home equity line to eliminate this debt.

6. Consider Working Longer and Delaying Retirement or Working Part-Time During It
This is probably an unpalatable suggestion for those contemplating a relaxed retirement, but delaying retirement is one of the most important levers you have if your aim is to make your money last during your golden years. According to two recent articles by researchers Robert Arnott and Anne Casscells ("Demographics and Capital Market Returns," in the March-April 2003 issue of Financial Analysts Journal and "Will We Retire Later and Poorer?" in The Journal of Investing, Summer 2004), the most plausible way to solve the dilemma created by baby boom retiree benefits weighing on the working generation is simply to keep the boomers working longer. While this may seem difficult, many boomers may make working longer their de facto option because they haven't saved enough. Working longer may also allow you to postpone taking Social Security to the point when you will receive substantially larger benefits.

7. Consider Moving to a Less Expensive City, State, or Country for Retirement
As everyone knows, the cost of living can vary widely between cities, states, and countries, so if you're looking to move to a less expensive locale for your retirement years, visit the areas you are considering and learn about the true costs (including tax consequences) of the move. Also, if you are nearing retirement and have been living in a part of the country that has seen a considerable runup in housing prices, you may want to consider downsizing your residence sooner rather than later. The proceeds from the home sale could go a long way toward helping your long-term finances.