Retiring on time is no accident. It’s the work of long-term thinking and careful planning, whether you go about it on your own or hire an advisor to help out.
Even those who do hire advisors would be better served to understand the mechanics of saving and investing. Think you know a thing or two about the matter? Take this five-question financial savvy quiz and find out:
1. A retirement account of $200,000 means you can safely withdraw what amount on an annual basis and expect it to last for 30 years?
Answer: C. $8,000. Financial advisors counsel taking no more than 4% of your retirement savings per year ($200,000 x 0.04 =$8,000). Conservatively invested, that level of withdrawal means the money should last for three decades. Take more, and you are counting on a higher, and thus riskier, investment return. Or you run out of money sooner.
2. The longer I wait to take Social Security, the more I will get paid once I begin benefits.
Answer: A. True. Many people take their retirement benefits beginning at age 62, the earliest possible age. However, if you were born in 1943 or later you will be paid an estimated 8% more money for each year you wait until the ultimate retirement age of 70 (your “full” retirement age may be sooner). You are likely to collect for fewer years, it’s true, but you might want to work for a few years past 62 in order to build up private retirement savings in a 401(k) or IRA.
3. A reasonably risk-adjusted portfolio that holds more stocks than bonds is likely to double your investment within what period of years?
a. Around 12 years
b. Around 10 years
c. Around 4 years
d. Around 7 years
Answer: B. Around 10 years. Many investors nearing retirement today have become used to stock market returns of 10 percent or more and doubling every seven years. However, the long-term return on stocks with dividends reinvested is about 6.6%. Held with bonds and rebalanced regularly, such a portfolio is likely to double your money in 10 years, not seven.
4. My 401(k) plan at work has fees that cost me what percent of my retirement savings balance every year?
a. Zero, it’s free.
b. Less than a half of 1%.
c. About 1%
d. Easily more than 1%
Answer: D. Easily more than 1%. In fact, 401(k) plan fees average 1.5%. Large-company plans tend to be the least expensive, while small company offerings can cost as much as 3.86%. That money is deducted from your total portfolio balance, not from the potential earnings in a given year.
5. The single most important investment I can make for retirement is to…
a. Own good life insurance
b. Have a paid-up mortgage
c. Maximize tax-deferred and tax-free savings
d. Build a cash emergency fund
Answer: All of the above, but mostly C. Maximize tax-deferred and tax-free savings. Life insurance is useful if something happens to you, but that is unlikely. Paying off a mortgage is great, but your interest rate is probably very low and there are tax benefits to paying it down slowly. Everyone needs a cash emergency fund of at least three months (six months is better). However, all of these pale in comparison to a 401(k) or IRA which earns you a tax break now or is tax-free later and compounds at a market rate of return.
Feeling better about your financial savvy? Great! Didn’t do so well? I recommend a trip to the public library. Try The Elements of Investing to start. It’s a short read and easy to understand, yet the concepts are important and timeless. Then start making choices that will get your retirement game plan on track.