You Bet Your Life

In your mid-40s or early 50s, the light suddenly goes on. "Oh, yeah," you say to yourself in the early-morning hours, "the day is coming when I'll actually retire." That's when the counting starts. How much do you have? How much will you need? How much damage did you suffer after getting your mind fried by the stock hypesters on CNBC?

So you run to a financial planner and ask, "Now what?" The planner crunches the numbers and offers you three choices: save more money, which means spending less today; work until 65 or 70 (assuming your health holds up and your company doesn't shove you out the door), or cut your retirement standard of living. This is pretty basic triage--nothing we haven't known. We just didn't want to think about it.

Think about it now. You can rescue your retirement by reassessing your resources: what you're saving, how much you're spending and how you invest.

Unfortunately, given their wishes, people usually resist spending less. Instead, you look for an easy out by trying to pump a higher return out of the investments you already have. If you lost big time in tech stocks, for example, you might decide to invest even more aggressively in biotechs, desperately hoping to win money back. You're in danger of being seduced (again) by salespeople promising 30 percent returns.

But if life is a poker game, you're drawing to an inside straight. Stock-market returns are the area over which you have the least control. There is no clever mix of stocks that will wipe out the need for adding new money to your retirement pot. "I think people should be more aggressive in saving rather than investing," says financial planner Karen Altfest of New York.

You already have a retirement "plan" whether you realize it or not, says planner Harold Evensky of Coral Gables, Fla. Whatever you're saving now, plus Social Security and maybe a company pension--projected forward--determine your future standard of living. Everything you spend is gone, gone, gone.

You've heard plenty of arguing about whether to count on Social Security. But everyone roughly 50 and up will almost certainly get it, probably in its present form (the government will run deficits to pay). The program will also stay alive for younger workers, although future benefits will have to grow more slowly than they do today. Social Security is America's safety net--for those who save too little (most of us, apparently), worshiped Nasdaq, trusted Enronish company stock or lose assets due to divorce, ill health or fraud. The voters will want some guaranteed benefits, no matter what.

Federal and state pensions are safe, too, although employees will increasingly be encouraged to shift to 401(k)-type plans. This summer Florida will offers its workers a choice between the two.

Private-sector pensions are almost as safe. I'm speaking here of the classic plans that pay you a fixed amount each month, depending on how long you worked and how much money you made. "Employees have taken tremendous losses in their 401(k)s, but not in their pensions," says Larry Sher, director of research at Buck Consultants in New York. (There are exceptions, however. Enron's pension was linked to the price of its stock--so employees got socked twice.)

A modest pension benefit is insured by the privately fund-ed but federally mandated Pension Benefit Guaranty Corp., so you're at least partly protected if your company fails without enough assets in its plan to pay current and future retirees. But only 21 percent of the work force is covered by a private pension, says Dallas Salisbury, head of the Employee Benefit Research Institute in Washington, D.C.

The law says your company can't take away any pension benefits you've accumulated to date, but future benefits could change. The new "cash balance" pensions, for example, provide less to older workers (especially early retirees) and offer more to younger ones who quit for other jobs. "You can't rely on any one thing," says Ron Peyton, head of the pension-consulting firm Callan Associates in San Francisco. "Supplement your pension with IRAs and 401(k)s. It's not as if the company will take care of you anymore."

Retiree life and health insurance are another question, says Olivia Mitchell of the Wharton School's Pension Research Council in Philadelphia. They're not guaranteed. Polaroid's employees lost both benefits when the company declared bankruptcy. At most other companies, the portion of the bills that retirees pay is gradually going up, so that's another expense to add to your budget.

As for 401(k)s and other investments, they're only as good as you make them. Americans threw out the rule book during the stock market's bubble years. Prudence seemed so very... old. Today it looks fresh--at least through the prism of the dot-com blowout and the 79 percent collapse in techs.

To me, the most useful guide is the investment time line. It starts by asking what you want your savings for and when you'll actually need the money. The answer leads you to the most suitable investment.

For example, ready money. By this I mean not just an emergency reserve but money you'll definitely have to spend within three or four years. Before the stock-market break two years ago, it sounded dumb to suggest that you stash, say, tuition due in 2002 in a low-yield money-market fund or short-term bond fund. But if you bought stocks with those savings in 1999, where is your tuition now? Safe investments carry low returns--1.4 percent on money-market mutual funds today and 2.2 percent on one-year Treasuries. But here, yields aren't the point. You're looking only for certainty.

Then there's reasonably stable money--your portfolio's ballast. It consists of medium-term, investment-grade bonds or bond mutual funds. They're also a good way of holding money that you might need within five to 10 years. Like stocks, bonds seesaw in price, but not nearly as much. They give you a lift in recessions when stocks fall. If you'd had 30 percent of your money in bonds in January 2000, you'd be looking at only a 10.4 percent decline in your total portfolio, compared with a 22.6 percent decline in the S&P 500, according to the research firm Ibbotson Associates. "All my clients have bonds," says financial planner Mark Sievers of Fairfield, Calif. "I want to minimize their consumption of Maalox." A 401(k) alternative is the stable-value funds. They carry a fixed rate of interest over a certain number of years.

Last on the time line is money to be held for 10 years or more. Retirement plans offer you a range of stock-owning mutual funds, leaving it to you to diversify your holdings well. Consider both stock funds and bond funds, with no more than 5 percent of your money in the stock of the company you work for. If you're stuck with a higher percentage because your company uses stock to match your annual contribution, switch out of it as soon as you can. Remember Enron. Don't bet your life on the company just because its stock is going up.

There's no "best portfolio" for everyone. But here's a place to start, for an investor of moderate tastes who's managing money for his or her own retirement:

Stocks vs. bonds: Subtract your age from 100 and add 10. That's the portion of your portfolio to put into stocks. At the age of 40, that implies 70 percent stocks, 30 percent bonds. To be aggressive, shave the bonds.

Types of stock funds: If your 401(k) has an S&P index fund, which follows the market as a whole, put the bulk of your stock investments there. When you're 40, that might account for half your money, with the rest divided among small-company, midsize-company and international funds, says planner Michael Chasnoff of Cincinnati. If there's no index fund, you might split that part of your investment between a big-stock growth fund (which buys companies whose earnings seem to be rising fast) and a value fund (companies that seem ready to stage a turnaround). Where there's no international fund, buy it outside your 401(k).

Lifestyle funds: You'll find these in some 401(k)s. They're prepackaged portfolios of stock and bond funds, with the allocation already arranged for you. You can put all your 401(k) money here and let the manager keep your investments in balance. A good idea, I'd say--especially for new investors.

As for the stock market itself, "people are between sobered and shocked," says planner Harold Evensky of Coral Gables, Fla. Over the past four calendar years, the S&P 500 returned just 5.66 percent a year, and worse for investors crowded into techs, dot-coms and aggressive-growth mutual funds. For the Nasdaq to return to its 5000 peak over the next five years, it would have to rise by an average of about 27 percent a year, says Randy Lert, chief investment officer of the Frank Russell Co. in Tacoma, Wash. How likely is that? After the market plunge in 1972, the then glamour stock Xerox didn't recover for the next 21 years.

Many investors thought you could pick 10 or 15 stocks and hold them, "but what appeared be good-quality names no longer are," Chasnoff says. Academic studies show that to be properly diversified today, you'd need to own 40 to 50 individual stocks.

What's more, it's an error to assume that the S&P stocks--if held long enough--will always match the 12 percent a year they returned in the last century. Over 20-year periods, for example, chances are one in five that stocks will rise by 7 percent or less, say finance professors Charles Jones and Jack Wilson of North Carolina State University. Even over 40-year periods, chances are almost one in five that you'll earn 8 percent or less. So approach retirement projections with humility.

Here's a general look at where you should stand in your planning now.

At 52, it's well past time to start plotting the retirement you want. Your quick calculations may assume a further 13 years of work, but your employer might have other ideas. Estimate how much money you'll need (see the Moneycentral retirement planner at NEWSWEEK.MSNBC.com). Some lucky people can cover their living expenses with a company or government pension plus Social Security--especially two-income, two-pension couples. If you'll be drawing on savings, figure on taking no more than 3 to 6 percent of your nest egg every year. By now you should be saving 15 to 20 percent of your salary annually. Get rid of all consumer debt. Prepaying your mortgage would also be a good idea. The less overhead you carry, the easier retirement will be. If you still have young kids, you'd better have prepared for another job.

At 42, college expenses loom before retirement does. Parents rarely accumulate enough money to pay as you go. You and kids both borrow, which raises your cost by the interest rate you pay. The big news here is the stunning new tax break offered to families who save. Starting this year, your investments in state-run college savings accounts, known as 529 plans, grow tax-free if used for school. Nearly half the states give residents a special state-tax deduction for contributing.

If you can't save for college and retirement, too, save for retirement first. Your kids can borrow their way through school, but for retirement you have to bring cash. "That's one of the hardest parts of my job," Sievers says, "getting people to be realistic about the true costs of what they want to accomplish." At this age, at least 10 percent of your earnings should be stashed away.

At 32, retirement isn't on your mind. You're thinking about your career, furnishing a home, maybe starting a family, having fun. You have no idea how fast your income will grow or how your life will change. But thirtysomethings can still take two very practical steps. First, join your company's retirement plan, if there is one. If you're self-employed, hook up with a mutual-fund group to start a Keogh, IRA or SEP retirement plan with money deducted automatically from your bank account. Put in at least 5 percent of pay, and then work up. Automatic saving has a special virtue: it makes you live on less than you earn without even thinking about it.

If you know people who have lost their jobs (and these days who doesn't?), you can also relate to the need for having cash savings on hand. The sooner you catch the savings bug, the better off you'll be.

At any age, a slide in the value of your stock investments means that you'll have to put extra money away to keep your retirement fund growing at a decent rate. Back when you were projecting how large a nest egg you'd accumulate, you probably figured that it would grow at a steady state--say, the classic 12 percent a year. Those gains didn't materialize, so you have to make up the difference yourself. Or else fall back on the only strategy left: inherit from your mom.