How to Invest for a 40-Year Retirement
Have a seat, won’t you? Maybe take a deep breath too, because we have some good news and some bad news.
At this point in your life, you almost certainly have some milepost numbers in your head that are shaping your plans for the future. Some of those numbers have dollar signs attached, of course, but just as important are the ones pegged to birthdays. Chances are you’ve been basing your retirement planning—the amount you’re saving, where you plan to live, the lifestyle you intend to fund—on an estimate of how long you will live.
The good news: You probably underestimated.
The bad news? Same.
You’re far from alone in this. In fact, 40% of retirees underestimate life expectancy of people their age by at least five years, according to a study by the Society of Actuaries. One gigantic study by the University of Michigan asked 26,000 Americans 50 and over, back in 1992, how many of them would make it to 75, and then tracked exactly how many did. As of this year, the results are in: Those who said they had a 0% chance of reaching 75? Half of them made it. And among those who said they had only a 50/50 chance, 75% did.
Part of the problem stems from a misunderstanding of statistics. Stats from the Centers for Disease Control and Prevention say that American men born today can expect to live 76.5 years, on average, and American women 81.3. But those numbers reflect life expectancy at birth and are dragged lower by people who die young.
By the time you are in your fifties, you have already outlasted everyone born the same year as you who passed away under untimely circumstances. For you, those oft-cited “averages” are virtually 100% inapplicable. You can probably expect to live much longer. And while various troubling social factors, including unequal access to health care and the impact of the opioid crisis, have stalled the growth of the average U.S. life expectancy in recent years, odds are that America’s higher earners will live longer—maybe much longer—than they expect.
“Remember that longevity isn’t uniform across the population,” says Wade Pfau, a professor of retirement income at the American College of Financial Services in Bryn Mawr, Pa. “For those at the higher end of wealth distribution, with better education, income, and health care, longevity has been increasing by about two years every decade. Those people can expect to live three or four years longer than average.” And the older you get, the more that advantage compounds.
For the very wealthiest, of course, there’s little financial downside to the likelihood of five or 10 more years on earth. But for most middle- and even upper-middle-income earners, the prospect of making one’s savings stretch into what seems like an endless retirement is a daunting one, increasing the uncertainty around how to invest, how to pay for medical care, and whether you can leave a legacy behind for the kids or your community.
It’s also daunting for the financial services industry, where a cadre of advisers and mutual fund companies are reinventing themselves to work with, and for, people who may need to finance a 30-year retirement. And at a time of political uncertainly and rising U.S. government debt, where the long-term viability of pillars of retirement-age financial security like Medicare and Social Security is increasingly in doubt, the urgency of preparing for a long post-career life becomes that much greater.
So first things first: Congratulations on those extra years. (Don’t let financial challenges obscure the value of the gift of time.) But second: Get ready to take a longer, more careful look at your retirement plans. Because if you’re likely to live to 95, or 105, you may need to throw out the old playbook and draw up a new one.
That reexamination can create the kind of push-and-pull that Bev and W. Davis (“Dave”) Hobbs are having with their financial planner. The retired couple from Eastham, Mass., both 66 years old, have done pretty well for themselves, with a classic home on Cape Cod and a successful business they just sold last year.
But when they started pulling $10,000 checks from their portfolio a little too often, their financial adviser, Jim Guarino, started pulling his hair out. After all, Bev’s mom lived until 92, and her grandmother until 94, so the odds that Bev could keep on trucking into her mid-nineties are very solid indeed. (Dave, whose family history doesn’t include as many old-timers, expects to live to around 82.)
With that longevity horizon, even the $1.5 million the Hobbses squirreled away from their company sale could run out if the couple spend too fast. So Guarino pulled out the charts and graphs, went over the couple’s spending line by line—and begged them to reduce their monthly drawdowns to $7,800. “He explained that if we kept spending at this rate, we would run out of money by the time I was ninetysomething,” Bev recalls.
The Hobbses took some of Guarino’s advice, like using a home-equity loan rather than savings to cover home repairs, and looking into long-term-care insurance. But they also remain dead set on pricey upcoming trips to Belize and the New Orleans jazz festival. Let’s just say the debate and the adjustments are … ongoing.
Even for the most diligent savers and investors, the prospect of funding decades of retirement is daunting. It’s psychologically challenging to put off satisfaction in the present for security in the future—much less decades in the future. It’s human nature that we estimate our longevity based on the longevity of our parents, or grandparents. The realization that we’re likely to live much longer than they did may come as both a blessing and a curse: More years means more time to travel the world, scratch off bucket-list items, or volunteer for favorite causes. What it also means: More years to pay for all that, more years for the mind and body to break down, more years to worry about becoming a financial burden on your family.
These financial anxieties of old age are particularly resonant in America. Author and London Business School professor Lynda Gratton, along with her coauthor, Andrew Scott, had a simple premise in mind for their 2016 book, The 100-Year Life: What is going to happen to us all, when everyone starts living to 100? “One of the most resounding comments in the U.S. was, ‘My savings are going to run out,’ ” says Gratton.
So yes: More years, more problems. Thankfully, there’s no shortage of solutions. There are financial strategies that combat longevity risk, no matter your current age. Younger savers obviously hold a massive advantage, having so much runway left to save, stockpile, and plan. But even people in their fifties and sixties have plenty of time to make portfolio tweaks, alter their timelines, rethink their savings rates, and ensure that they don’t outlive their money.
Society’s “longevity risk,” as financial planners call it, has been a slow-developing crisis, more a rising tide than a sudden storm, so top investment minds have had some time to prepare for it. “This is not a sudden surprise,” says Roger Ferguson, president and CEO of retirement-plan provider TIAA. “We annuity writers have seen this coming.”
In response, financial services companies are building longevity risk more intrinsically into their products. To witness how longevity is changing the business, just look at target-date mutual funds (TDFs). The one-stop shopping cart of retirement vehicles, they are designed to put you on a comfortable “glide path” toward retirement—owning more equities when you are young, more fixed income and cash when you are older—while keeping investors from having to make potentially wealth-destroying decisions about timing the market. (The “target date” roughly corresponds to the year the hypothetical investor reaches retirement age.) At a time when many mutual funds in general have fallen out of fashion, TDFs have gobbled up the investing world, having amassed $1.07 trillion in assets at the end of October, according to research shop Morningstar, up from $116 billion at the end of 2006.
But because of longevity risk, target-date funds have changed. Many used to be “To” funds, fixing investors’ asset allocation at their retirement date and staying there. Nowadays the vast majority are “Through” funds, designed to carry customers to the end of life. They keep equities fairly high and tinker with allocation for 20 or even 30 years after retirement, and they tend to own more stocks. An added bonus: That nod to longevity has made for superior returns, notes Morningstar.
The industry’s personal touch is changing too. Financial planners are scrambling to get certified as retirement-income specialists who can steward customers through 20 or 30 years of retired life. That is why you may see a flurry of additional letters after their names these days. One such cluster might be Retirement Income Certified Professional, or RICP, a designation awarded by the American College. That program started in 2013: There are already more than 5,000 active RICPs and 10,000 more enrolled.
Planners can also become a Chartered Retirement Planning Counselor, or CRPC (28,600 grads, 2,000 enrolled); or a Chartered Retirement Plans Specialist, or CRPS (6,000 grads, 500 enrolled), both programs administered by the College for Financial Planning. All these designations indicate your planner has been loading up on additional training not just to get you to retirement, but also to successfully manage the many years that will follow.
Perhaps the biggest clue about what the future holds: Ask retirement experts, who are buried in longevity data all day, about how long they themselves plan to live. How about Wade Pfau, for instance, one of the industry’s foremost retirement authorities? “On my spreadsheet, I have worked it out until 105.”
In case you haven’t worked it out that far, here’s what you can do about it.
Strategy One: Work Longer
Let’s get this one out of the way first: Working longer will change the math in your favor, and powerfully so. It may not be the laid-back future that many associate with the word “retirement,” but just a few more years of working and saving, rather than drawing down assets, is a game changer.
That was the conclusion of the Stanford Center on Longevity, in a collaborative project with the Society of Actuaries. Researchers tested a blizzard of potential “drawdown strategies”—that is, hypothetical rates of spending in retirement, mapped against investment returns on people’s savings—to analyze which had the best chance to keep up with inflation and sustain a portfolio through a long retirement.
“One of the conclusions we came to pretty early on was that the traditional notion of retiring in your early sixties was a bad idea,” says Steve Vernon, a research scholar at the center. “If you’re going to last into your mid-eighties or beyond, most people don’t have enough savings to generate the income needed to keep them going.” So where retirement timing is concerned, Vernon says, “70 is the new 65.”
In practice, many of us don’t even stay on the job until 65. The average U.S. retirement age has been steadily rising, but it’s still only 63, according to an analysis of Census data by the Center for Retirement Research at Boston College. That reflects both voluntary early retirement, by those who have hit their goals, and involuntary departures by those whom job losses or health concerns have pushed out the door.
If you can keep clocking in until age 70, not only are you building up your savings instead of chipping away, but you are also enabling yourself to delay the start of Social Security. The allure of that: Every month you put it off, up to age 70, the amount you’re paid in the future rises. Let’s say your monthly benefit at age 66, the current “full retirement age,” is $2,500. Put it off until 70, and that monthly figure becomes $3,300—a 32% raise that you’ll collect for life.
There are exceptions to this rule of thumb, of course: Some married couples, for example, can collect more benefits if one opts to take Social Security earlier while the other keeps working. But for most people, says Vernon, delaying Social Security is so smart that, if you need some cash to tide you over until 70, it may be worth dipping into savings to do so. It may be counterintuitive to start drawing down your assets early, but the prospect of a higher lifetime payout later just makes too much sense.
Working longer isn’t just a financial issue. Studies have demonstrated that remaining in the workforce sustains cognitive functioning, preserves social networks, and can even delay the onset of Alzheimer’s. (For more about how to work later in life, on your own terms, read “Why Consulting Can Be Better Than Retiring.”)
“Think about it: If you retire at 60, and you live to 100, that’s a hell of a lot of time,” says Gratton, the London Business School professor. It’s so long, in fact, that Gratton suggests we completely jettison our traditional conception of the three-stage life—education, work, retirement. In its place, we should think about a “multistage” life in which every stage expands.
Educational breaks, like the pursuit of an additional degree, can be inserted into your working career (keeping your skills updated and helping you remain relevant to employers). Mid-career sabbaticals can act as early “retirements,” allowing you to travel the world or do other things to recharge, before you return to the workforce. What all these ideas have in common: Making the most of extra years.
Strategy Two: Upgrade Your Portfolio
How should your investment approach change, in a world where you could very well live to 100?
The most conventional guideposts out there are pretty old and creaky. Take the idea that your exposure to the stock market, in percentage terms, should be 100 minus your age—so a 90-year-old might have 10% in the stock market and the rest in fixed income and cash. That may have made sense from the 1960s through the early 2000s, when annual interest rates on ultrasafe Treasury bills routinely topped 5%; it looks less smart in the low-interest-rate new economy.
Here’s a better tip: Think like a target-date fund manager. Here’s why. The raison d’être of these investment products is to build assets in a thoughtful way, give you increasing safety as a retirement date draws near, provide enough diversification to keep your portfolio balanced during market jolts, and generate returns long after you’ve retired. In short, these are the people digesting all the latest longevity data and coming up with the right investment recipe to make a customer’s money last.
Here is the reality such managers face: Equities are the best (and likely the only) asset class primed to keep your portfolio chugging over the very long term. The S&P 500 has delivered a 9.5% annual return going back to 1928, according to a study by NYU Stern School of Business finance professor Aswath Damodaran. And with global interest rates so low, fixed income and cash alone are unlikely to enable your savings to keep up with your cost of living after retirement.
Jake Gilliam, senior portfolio strategist at Charles Schwab Investment Management, plays a role in constructing that company’s expansive target-date product line. Back when the firm rolled out target-date products, he says, the funds were designed to shift gradually toward a retirement allocation of 25% equity and 75% fixed income. But in the mid-2000s, data about growing longevity helped convince the company that the “To” model wasn’t going to get the job done anymore. So Schwab moved to the “Through” model, with allocations shifting even during retirement years.
The new mix: 40% equity and 60% fixed income at retirement, with the heavier dose of stocks providing more upside potential. Schwab’s target-date funds do eventually reach a 25/75 split—but only after 20 full years of retirement. “We now manage assets through an expected life span of at least age 85,” Gilliam says.
The change in asset percentages was only one of several noteworthy tweaks. Schwab managers meet for formal reviews every year to adjust target-date funds’ underlying assets with an eye to boosting returns. In recent years they have added international equities and small-cap stocks—asset classes that come with higher volatility than sturdier blue chips, but also offer the promise of higher returns.
They’ve also spiced the loaf with assets like global real estate and Treasury Inflation-Protected Securities (TIPS), whose returns generally rise with inflation. The goal: to have an asset mix sufficiently diversified so that when one part of the market crashes, investors won’t feel the need to go fleeing for the exits. These assets are all riskier, in the short run, than plain-vanilla bonds, but a retiree with a long-term time horizon can’t afford to shun the rewards that come with those risks.
Investment giant Vanguard Group goes even heavier on equities than Schwab does, to power decades of retirement returns. Its target-date funds are composed of 50% stocks at retirement, a percentage that glides down over the next seven years to 30%, where it stays.
Its investment strategists are envisioning a 30-year time horizon beyond retirement at 65. In other words, even if you aren’t picturing yourself at age 95, senior investment analyst Maria Bruno is. Bruno is part of the Vanguard strategy team putting the firm’s products together. “It’s good to use 30 years of retirement as a general guideline,” says Bruno. “And when you are making projections, you should always err on the conservative side—maybe even going all the way to 100 or 110.”
Strategy Three: The ‘Drawdown’ Showdown
For most of their lives, retirement savers (and their brokers and advisers) focus on asset accumulation. But that phase is just the beginning of your retirement challenge. The other half of the equation is the drawdown: How much you will chip away, each year, at everything you have built up.
Conventional wisdom is that a 4% annual drawdown rate is the way to go—a withdrawal big enough to keep your retirement years comfortable, but not so big that you risk running out of money prematurely. To which Wade Pfau says nope. “With people living longer, the 4% rule has become a lot less safe than it used to be,” he says. “I think a 3% figure provides the same amount of safety that people generally attach to the 4% rule.”
To use a concrete example, if you have a million bucks socked away for retirement, drawing down $30,000 a year (in addition to any other sources like Social Security or pensions) is a conservative enough choice that you should be able to sleep at night, confident that even extreme swings in the market won’t harm your ability to keep your portfolio healthy into your nineties. Take out $40,000 a year or more, Pfau argues, and statistical models suggest that you are starting to stress the long-term viability of your portfolio. (In either model, you’d adjust your annual withdrawal to keep up with inflation.)
For all but the wealthiest, this advice can sound both spartan and constraining. After all, we aren’t robots, and no one has the exact same monetary needs every single year. That’s why other advisers suggest another way to come at the drawdown problem: Be flexible about it.
Vanguard’s Bruno prefers to think about a “floor and ceiling” approach. In her models she uses a 2.5% annual drawdown as a floor and 5% as a ceiling. The rate you choose depends on how the market performs the previous year. If the S&P 500 has a boffo year, go ahead and feel comfortable about a 5% drawdown, moving that money out of your retirement accounts and into the bank at the start of the following year. (Based on 2017’s performance, it looks as though this is what you’d be doing in 2018.) If the market has had a down year, try to restrain your spending with a 2.5% rate.
Not only does this method recognize the realities of life, but it “increases the longevity of your portfolio,” Bruno says. It keeps you from selling more assets when the market is lowest, giving your portfolio a few more years of life.
Strategy Four: ‘Longevity Insurance’
As all of the above suggests, even a substantial nest egg may not be able to cover all the exigencies of a blessedly long life. That’s why the idea of “longevity insurance” has become a cornerstone of preparation for a longer retirement. One form of such insurance is an annuity; another is long-term care.
The term “annuity” has taken on toxic overtones in some circles in recent years. That umbrella definition covers a wide range of relatively complicated and expensive investment products that have been associated with high-pressure sales tactics and inscrutable rules about fees and payouts. But strip away bad actors and financial engineering, and the concept makes eminent sense in an era of increasing life spans. In its simplest and least expensive form (often called a “simple income annuity”), an annuity gets you a potentially riskless stream of income: You give an insurer a lump sum, and in exchange you get a lifetime of payouts, akin to Social Security checks.
The longer you live, the more money you derive from the transaction. If you die early, the insurer gets the better of the deal—but frankly, you won’t be around to regret it. Another increasingly popular product, sometimes called the deferred annuity, makes this tradeoff even starker. In return for waiting for payouts to begin—for 10 years, say, or until you turn 85—you pay much less upfront than you would for an annuity that paid you immediately.
For most retirees, devoting all your savings to this is the wrong move. But funding an annuity with a portion of your assets can help fuel a lifetime of monthly checks that—when paired with other income and investments—forms a powerful three-pronged solution. “To purchase guaranteed income for life, at a low cost, can be a very good strategy,” says Vanguard’s Bruno. “In conjunction with Social Security, those are two pretty big tools in your toolbox.”
Long-term-care policies are essentially another kind of longevity insurance—and a vexed one for many families. Their very existence reflects the fact that Medicare, which most retirees rely on for health coverage, does not cover nursing-home care. Should you need regular assistance, either in a nursing facility or in your own home, you usually have to self-fund, either through insurance coverage or your own savings. Medicaid picks up the tab only after you’ve exhausted your own assets.
Nursing homes, obviously, are not cheap. The average nationwide cost for a private room is now $8,121 a month, according to a new study by insurer Genworth. But only 8% of the population is covered by private long-term-care policies, in part because the coverage itself is fairly pricey and complex. Premiums typically range from $2,500 to $6,000 a year, and insurers that provide it have been hiking those premiums in recent years, and in some cases trimming the benefits they offer, in response to unexpectedly high costs. Rules of thumb: Buy it when you’re younger and healthier, to capture a lower premium rate, and run the numbers with an adviser to make sure the cost of coverage won’t derail your savings.
All of these strategies require savers and investors to picture themselves at 85, at 90, at 100. That’s an exercise that’s counterintuitive to us, in part because, for most people at most points in human history, that kind of longevity was utterly out of reach. But we are getting to the point where that person is not just possible—he or she is becoming probable.
“Before, people used to retire at 65 and then live another 10 years and that was it,” says Pfau. “Now we are living another 30 or 40 years, so it is almost like every year of work has to fund a year of retirement. That’s just not feasible … As life expectancies get so high, we have to start looking at everything differently.”
A version of this article appears in the Dec. 15, 2017 issue of Fortune with the headline “Investor’s Guide 2018: Retirement — The Very Long Game.”