The simple question, "How much money do you think you'll need when you retire?" may elicit any of these reactions: horror, because who wants to be thinking about old age and eventual death??; misery, because not everyone has the means to save for retirement; and finally, an exasperated sigh, because planning for retirement is frankly a maze of confusing numbers and meetings with financial advisors.
Common knowledge would tell us that it's easier and more convenient to turn to a financial advisor or financial analyst who can sort it all out and who will be busy making our money work while we're asleep. But one of the dirtiest secrets in the wealth management industry concerns these so-called experts and how much they can really help.
In his Last Week Tonight episode "Retirement Plans," John Oliver lays out an ugly — if hilarious — picture that sets the story straight on retirement planning and those helpful retirement service ads on TV.
The Dark Secrets of Retirement Planning
The finance books are right on one point: saving for retirement is something everyone should do.
But not everyone's doing this, for various reasons. A recent survey by the Employee Benefit Research Institute found that about 47% of Americans have saved less than $25,000 for their retirement. They may take consolation in that they have some form of savings, but the harsh reality is that by the time these people reach retirement age, their money won't be enough. The only way saving works is if someone takes on an aggressive retirement savings plan while still in their productive working years.
In many instances, the lack of retirement savings is not because of unwillingness to start putting money aside. The reality is that most people simply don't make enough money to allow them to save. They're hardly getting by when it comes to day-to-day expenses, so how could they possibly think about something as far off as retirement? Others are saddled with debt from credit cards, mortgages, and student loans that they're still trying to pay off.
Yet this is just one side of the coin. For those who actually have the means and the resources to start planning for retirement, there's also the challenge of muddling through the massive pile of retirement plan options out there. Should I get a 401(K) plan? Are stocks okay or should I go for bonds? Should I listen to my advisor and put my money in a managed fund?
And then there are deceptively simple but crucial questions like, "What fees do I need to know about?" and even, "Do I need a financial advisor?"
It's these last two that are the subject of Oliver's satirical attack on the minefield that is retirement planning. Planning for retirement already sounds complicated, and when you're misinformed on the basics like fees and financial advisors, then navigating this maze can be a frustrating and traumatic experience with some serious repercussions. That's why you need to get ahead of the titles and finance jargon that can confuse you into making bad decisions.
Secret 1: What "financial advisors" really are
In Last Week Tonight's "Retirement Plans" episode, Oliver lifts the rose-colored glasses to reveal the truth: financial advisor is simply a generic term that any investment professional can use, even without any credentials. In Oliver's words, it's a term that "doesn't mean anything" at all.
Here's another tip: unless they're fiduciaries, then a financial advisor can just very well run away with your money – figuratively, at least. Oliver explains that advisors are paid by commission, and in a lot of instances, the recommendations they offer are made because they stand to benefit and gain from them. And before you think it's a crime – no, it isn't, because, as Oliver points out, it's actually legal for financial advisors to put their financial interests ahead of their clients'. Unless they're fiduciaries, in which case they're expected to act in their client's interests first.
Secret 2: The truth behind the 401(K) plan
Don't get us wrong, 401(k) plans are actually good. Any employee would be smart to snap up a 401(k) retirement plan offered by their company even as an additional fall back plan. But the convenience that you get from not having to deal "directly" with the whole business of saving for your retirement also means you'll be saddled with fees – lots and lots of fees – that you really wouldn't notice unless you examine the numbers in closer detail.
Oliver calls 401(k) plans a "ghost mine for financial service companies" that are earning considerable amounts of money thanks to the fees they charge: legal fees, trustee fees, transaction fees, stewardship fees, bookkeeping fees, finder's fees, etc. If your company also makes use of a broker or a middleman, then your fees will be jacked up even more.
By the time you do realize that a significant portion of the money you're putting in every month is going to fees, you'll be given the frustrating rejoinder, according to Oliver, that the fees will eventually go down over time and that they're worth paying for the services of the broker and your financial company.
Except, naturally the opposite is true. As your money grows over time, your fees also add up because of compound interest. By the time you get your money years down the road, you may have already lost 2/3 of what you would have had, all because of fees!
Secret 3: The false lure of actively managed funds
It's hard to resist the lure of big money and great returns, which is what an actively managed fund almost always offers. Plus, there's also the added benefit of having financial experts doing the job for you, beating the market and taking calculated risks that can earn huge returns for your investment.
But again, we're corrected about this misconception: it's not always easy to "consistently beat the market," as Oliver puts it, and in the end, most actively managed funds perform worse than low-index funds.
A way out of the minefield
So, you're probably asking, "Is there a way out?"
There is, because we think (and John Oliver happens to agree) that retirement planning doesn't need to be complicated, daunting, or horrifying if you know these secrets and can create a fool-proof workaround strategy for yourself.
Finally, after getting our attention and freaking us out a bit, Oliver shows us how to do it right:
Start saving early
Take advantage of the principle of compounding — that the earlier you start saving for retirement, the more time you're giving your money a chance to grow. If you start saving $5,000 every year in your mid 20-30s with a 7% annual return, you'll have roughly over $600,000 in your retirement fund. There's about a hundred thousand dollars difference over a retirement fund that you'd start in your early 40s.
Sure, market conditions can have an effect on savings, but even in this situation, starting a retirement fund early will still create significantly greater rewards even if you stick to putting away the same amount each year. So let's say you just keep investing $5,000 every year from your mid-20s up till your early 60s, you'll still be sitting on over $1 million come retirement.
Look for financial experts that are fiduciaries
Oliver cannot emphasise enough the importance of working with a fiduciary – and not just any financial advisor or fund manager.
Unlike an ordinary financial advisor or fund manager, fiduciaries have the responsibility to put the interests of their clients ahead of everything else and eliminate any conflicts of interests especially including those where they stand to make money out of big commissions. If there's one person you should trust to help you make informed decisions concerning your money, it's the financial advisor who has taken the oath to be a fiduciary.
Due diligence is needed, of course. If you're scouting for an advisor, there's no shame in asking them outright if they're a fiduciary. Take a good look at a prospective advisor's documents if it states anything about subscribing to fiduciary standards. Ask about their fees. Advisors who follow a fee-only structure means that they're getting only what you paid them, but if they're fee-based, then it's likely that they charge a flat fee or otherwise earn from commissions.
Go for low-index funds
In an unpredictable and unstable economy, it's proving to be even more impossible to beat the market. It's no wonder that even investors themselves are ditching actively managed funds. Index funds are "passively" managed, require less risk, and have low management costs, all of which saves you more money. There are no fund managers who are susceptible to emotions like greed or the desire to beat the market, which means that no-one will be taking big risks with your money. This way, low-index funds reduce the chance for human error affecting your investment.
Move your investment from stocks to bonds over time
Stocks can give much more bang for your money than bonds, but if your objective is to protect the money that you hope to enjoy in your 60s and 70s, then it makes sense to go for bonds over time. Bonds are much more stable than stocks and you're less likely to lose money with them. They also pay you regularly, although not as much as what you'd be getting from your stock dividends. You'll still be assured of a steady stream of income.
It's also understandable why it makes sense to invest in stocks. Putting money in stocks won't hurt if you want to get the most out of your investment. You just need to devise a manageable strategy of stocks and bonds allocation. The rule of thumb is to use some of your money to buy some bonds and use some more to invest in stocks. This way you can reduce losses if the stock market goes down because you have a diversified portfolio.
You can begin with a moderately aggressive allocation of 80% stocks and 20% bonds. This would give you a rate of return of 8% or more. When you've significantly grown your initial stocks investment, you can consider going for a moderate growth allocation of 60% in stocks and 40% in bonds, giving you a rate of return of at least 7%.
Over time, you can choose more conservative allocations where you only have less than 50% of your money in stocks and the rest in bonds. The goal at this point is not to maximise the rate of return, but just preserve your capital investment and ensure that you'll have a solid and significant investment ready regardless of the condition and movement of the market.
Keep fees as low as possible
We now know how fees can significantly drain investment earnings. But unless you plan to just stash your retirement savings in an envelope in your bedside drawer or in a suitcase under your bed (which many not be the smartest moves to make for a whole lot of reasons), these investment fees are inescapable.
The only concession you can make is to find a way to lower the fees, and we already mentioned the first two solutions above. First, find an investor who's a fiduciary so you won't have to deal with hidden fees and exorbitant commissions. Next, go for low-index funds that are passively managed and therefore do not require as much management costs as actively managed funds.
Take the time to read the fine print
Finally, take the time to read the fine print and ask your broker or financial advisors all the questions we mentioned about fees (and whatever else you can think of). Even a 1% fee can make a significant dent on your earnings. According to the Securities and Exchange Commission, a $100,000 investment with a 4% rate of return can lose as much as $28,000 in 20 years even with only a 1% annual fee. This amount is already huge enough to fund another investment.
As John Oliver points out, the bottom line when it comes to navigating retirement plans is that no matter what anyone else tries to tell you, it doesn't have to be complicated.
You're already off to a great start now that you're armed with the basic knowledge of how to put money aside and how to find a finance expert who won't put their needs above yours.