Worried about your retirement plans? Get a report card

By Andrea Coombes
CBS.MarketWatch.com

SAN FRANCISCO (CBS.MW) - With something as complex as planning your finances in retirement, it makes sense to go back to the basics. And what's more basic than A, B, C, D and F?

"Finances can be a real abstraction for people (but) everybody knows how to relate to a report card," said Mo Barakat, a Los Angeles-based senior financial adviser with American Express, who uses letter grades to help his clients meet their financial goals.

"They're accustomed to wanting to strive for As and Bs. If you're a C student in the classroom, you typically know it. You could be a C student in your finances and never be aware of it," he said.

The grades help his clients focus on the task at hand - a financial plan for retirement - instead of worrying about a hot stock tip.

"People come to me because they want to know if the stock market's going up or down. I say, 'let's talk about this very important corporation called you,'" Barakat said. "Retirement is the most expensive thing you'll ever pay for. A lot of people don't get that."

That said, consider the following retirement planning issues - and assess whether you'll pass the final exam.

Cash flow Most people see retirement as the other side of the accumulation phase: We're done working, now's the time to start spending. But given longer life spans and rising health-care costs, retirees must ensure they're earning more in retirement than they're spending.

"The common perception is you're spending down assets in retirement (but many) successful retirees are saving money. That's not uncommon for successful retirees," Barakat said.

"Your cash flow can either be negative, break-even or positive. Break-even would be a C. Positive cash flow would be a B, and very positive would be an A," he said.

Inflation planning One hurdle to cash flow is inflation. "Certain studies have shown that over the last decade inflation has risen substantially more for retirees than it has for younger folk," Barakat said.

Rising health-care and prescription-drug costs make up a bigger chunk of older Americans' expenses, and retirees spend more on energy costs, also up this year, because they spend more time at home. All this as record-low interest rates have hit retirees' fixed-income accounts hard.

To get an A+ on the inflation conundrum, retirees and near-retirees must focus on real rate of return, which is return after taxes and inflation.

"A bond fund that pays a 6 percent dividend, let's say you give 1 percent to taxes, and 3 percent to inflation, you're down to 2 percent real return," Barakat said.

Set targets Also key to ensuring positive cash flow is understanding what your retirement needs are. Once you know what you'll be paying out, you can figure out what return you need your portfolio to earn. Finally, figure out which investment portfolio will get you that return.

Usually, retirees start at the wrong end. "They start with (picking a) mutual fund," Barakat said. And they don't set average annual return goals for their investments.

"I see this all the time: I ask a prospective client, 'what's the goal for this asset?' I get this shrug of the shoulders and, 'whatever the markets do,'" Barakat said.

Debt-service ratio As important as monitoring cash flow is controlling how much income flows out to pay debts. Retirees paying less than 15 percent of gross income to debt, including mortgage, get an A, Barakat said, while a debt-service ratio of 35 percent scores a C-.

"When you have a high debt service ratio, you rob yourself of your own savings," Barakat said.

"I have a client who is 50. He just took on a massive mortgage in California ... he'll have to work harder and save more money in the 401(k) as a result. He also may have to postpone retirement."

Debt-to-equity ratio A high debt-service ratio means a failing grade, but the degree to which you have assets backing up debt can help bring your grade up again, as you have the option to cash out assets to pay off debt.

A 20-year-old with debt representing 80 percent of assets rates a "low B grade," Barakat said, as does a 30-year-old with 70 percent debt-to-equity and a 50-year-old with 30 percent debt-to-equity.

"If you're 50-something and your debt-to-equity ratio looks like a 30-something, not good. Give yourself a low grade," he said.

Cash reserves While inflation eats slowly into cash flow, emergencies devour it. For working people, three months' worth of expenses stashed in a liquid account for emergencies rates a solid B; six months' cash on hand, an A+, Barakat said.

"If I get slapped with a $1,000 unexpected bill and it goes on a credit card, it can take me six to nine, even 12 months to recover," while someone with cash reserves "writes the check and moves on."

While those pulling in a paycheck need emergency cash to cover unforeseen expenses, retirees need cash to live on should a down market hit their equity investments.

"You want to make sure there is plenty of emergency money set aside to cover (expenses) for 12 months, until the market can turn and the less liquid investments will be back up," said Patrick Byrne, chief investment officer at Robert J. Reby & Co.

Risk management As retirees work to create a financial plan, they also have to be sure to protect it. "Some of the clients we come across get an A in the investment category - they're great savers, they've budgeted themselves - but they might be at risk because they don't have a long-term-care policy," Byrne said.

"Their retirement egg could be depleted because they're spending up to $70,000 a year on long-term care."

Risk management also means estate planning, and ensuring appropriate health and other insurance coverage.

"Auto insurance ... is probably someone's biggest liability," Byrne said. "If you don't have proper coverage (an accident) could wipe out your positive net worth," he said.

Mortgage uber alles Those near retirement get a D for focusing on paying down a mortgage to the detriment of stashing cash in retirement plans.

"There's a common perception out there that 'I have to have the mortgage paid off before I retire,'" Barakat said. But "what you put into the 401(k) you're going to get back as income. What you put into the home you're not - it's trapped equity."

Financial focus Retirees get As for either regularly meeting with a financial adviser, or keeping tabs on their finances themselves.

"Do you sit in the front row, or are you a slacker in the back row of your finances?" he said. "When you have bad financial focus, you're not thinking about the subject, you're not making careful financial decisions in terms of purchases."

Plotting progress over time is also important. "Where am I today versus 12 months ago and 24 months ago? We compare our clients to last year's numbers in every category," Barakat said. "Let's see how much you've improved in each category. That'll grab your attention."

Realistic asset base Even the best investment can't rescue a retiree who hasn't saved enough to begin with.

"A good rough rule of thumb is for every thousand dollars a month you need of after-tax, inflation-adjusted income ... you need about a quarter million dollars," said Greg Kasten, a certified financial planner and founder of Unified Trust, a wealth-management firm.

Under that formula, someone earning $55,000 in after-tax income who expects to collect $15,000 in Social Security benefits would need to replace $40,000 a year, or $3,333 per month - necessitating a portfolio of about $830,000.

Many people are on the verge of failing this subject. "Most people are trying to stretch income on portfolio amounts that are just way too small," Kasten said.

Once they realize the shortfall, they compensate by taking on too much risk in the stock market, Kasten said. Others find "they're left with cutting their standard of living or working part-time."

 

 

 

More Lending News

We make it simple for you..
Free Home Equity Loan
Quote  from 2-3 competitive
lenders nationwide.
Are you losing money every
month with the compounding
interest of credit cards?
Apply Now for a Home Equity
Loan that will Save you$$$
No Appraisal Required for
Loan Amounts up to $30,000
Request Info from Lenders
Stated Income Loans are
Available up to 100% of
your home's value.
Consolidate Your debt & Lower your monthly payments Apply Now for a consolidation Loan that will Save you$$$



Get Prequalified| Second Mortgage | Home Equity Loans | Home Equity Line of Credit | Debt Consolidation | Loan Programs | Apply Now | About Us | Disclaimers

This is not a commitment for a loan or an ad for credit as defined by paragraph 226.24 of regulation Z.
Copyright, 2003 -2004, Home Equity Loans Center.