Reading a report on retirement by Bernstein Global Wealth Management the other day, I was pleased to learn that our prospects for staying alive on this beautiful earth are growing brighter. A male who reaches age 65 has a one-in-two chance of living beyond age 85 and a one-in-four chance of living beyond 92. Women can expect to live two to three years longer than men. And get this: For a couple reaching 65, either husband or wife has a one-in-two chance of living beyond 92 and a one-in-four chance of living beyond 97.
These figures, from the Society of Actuaries, were compiled in 2000. Because longevity keeps increasing, it's a good bet that if you're 35 today, you will have an excellent shot at becoming a centenarian. But because we're living longer, the bad news is that we need a good deal more money to support ourselves in lengthier retirements.
The retirement ratio
Alex Pollock, my colleague at the American Enterprise Institute and the former president of the Federal Home Loan Bank of Chicago, illustrates the problem with what he calls the work-to-retirement, or W/R, ratio. In the early 1960s, life expectancy for males at birth was just 69. Assume that a man then started work at age 20, retired at 65, and died at 70. He had five years of retirement, so his W/R ratio would be 45 to 5, or 9.
Today, we start work later, retire earlier and live longer. So, writes Pollock, "A person who began work at 22, retires at 62 and lives to 82 would have 40 years of work and 20 of retirement. With a W/R ratio of 2, the required savings rate to finance retirement is too high -- about 14% of pretax income saved throughout the working life."
What's the solution? Working longer will boost the W/R ratio. Saving more before retirement will help your nest egg last. But another answer is to reconfigure your investments so that they perform better. Although reaching for higher returns means accepting higher risk, the volatility of your assets isn't the only danger. After all, what could possibly be riskier for a retiree than running out of money?
That is why Bernstein, a firm with a reputation for circumspection, emphasizes stocks in its report: "The problem with overdependence on fixed-income investments is that a retirement portfolio should be designed to ensure a client's financial well-being for decades -- not years -- and therefore needs to generate growth, not just income."
There are three problems with bonds. First, although they produce a reliable stream of income, they don't adequately protect you against inflation. Stocks beat inflation during each and every overlapping 20-year period between 1950 and 2005, but bonds beat inflation only 70% of the time. Second, bonds return far less than stocks -- on average, just 2.3% a year after inflation between 1987 and 2006, compared with 7.4% for stocks. Even in bad times, stocks tend to beat bonds. Between 1967 and 1986, bonds actually lost an annualized 0.5% after inflation; stocks gained 2.1%. The tax treatment of bond income (except for municipals, which have very low yields) is unfavorable compared with that of capital gains and dividends on stocks. For tax-deferred accounts, this deficiency can be overlooked, but most of us also have taxable savings for retirement.
Somerset Maugham once wrote a short story, titled "The Lotus Eater," about a man who went to work as a bank clerk at 17, retired at 35, used his savings to buy a 25-year annuity and, assuming he would live to age 60 (a W/R ratio of just 6 to 5), retired to Capri, the idyllic island off Naples. Unfortunately, he outlived his income and struggled in misery as an aged beggar. The object of a retirement portfolio, Maugham reminds us, is to keep us comfortable until we die -- whenever that may be.