Old school: The percentage you should have in stocks is 100 minus your age.
The idea behind the old "rule of 100" is that the younger you are, the more risk you can tolerate. But as the market crash of 2008 proved, recovering a 30 percent loss is not gaining 30 percent, but gaining 50 percent, because you are rebuilding from a shrunken base, explains Ike Ikeme, assistant professor of finance and economics at Salt Lake Community College in Utah. "It doesn't make sense anymore," Ikeme says. Instead, rebalance your portfolio to stay on track for your targets, adjusting for market trends.
Old school: Retirees should be in bonds.
New rule: Retirees need growth.
"A lot of people think that they should invest heavily in bonds. That's from the 80s or 90s, when bonds were paying well," says Scott Nelson, an advisor with Sagemark Consulting, in Westlake Village, California. "Clients really want to go heavily into bonds when they are three to five years away from retirement. They think they're protecting everything, but in reality they're exposing themselves to more risk because of interest-rate changes."
He says the solution is to always keep a slice of your portfolio in growth investments.
Old school: Count on an 8 percent compound growth rate.
New rule: You probably can't count on it, at least if you have a balanced portfolio.
Just do the math, suggests William Reichenstein, the Pat and Thomas R. Powers Chair in Investment Management at Baylor University in Waco, Texas. With today's five-year Treasury yield at 1.6 percent, and assuming the Standard & Poor's 500 index hits a 4.8 percent geometric average over the next five years, a portfolio that is half stocks and half bonds will earn 4 percent, Reichenstein estimates. "Based on today's miniscule bond interest rates, multiyear returns on balanced portfolios will likely be about half the 8 percent rate that was assumed in other return environments. And that forecast assumes stocks will outperform bonds by their historic 4.8 percent average," he says.
Old school: In retirement, you can live on 75 percent of what you need today.
New rule: It's more like 100 percent.
Retirement starts out fun, and travel and activities cost money -- much more than people assume, Nelson says. Then life slows down a little, but medical costs pick up. Inflation marches on regardless, eroding your buying power. These hard truths shatter the delusion that you can live more cheaply in retirement than you do now, he says.
The solution: Diversify your portfolio to include some nontraditional assets, such as commodities, and, if possible, an income stream from commercial real estate, for example.
Old school: Withdraw 4 percent annually from your portfolio.
New rule: Sure, if you'd like to guarantee that you'll go broke.
This rule is crumbling in today's merciless economy, according to Reichenstein. It used to be that the 4 percent rule would stretch your money over 30 years. But it assumes a 50 percent allocation of stocks, something many retirees can't tolerate. This rule is also a simple calculation that never took advisors' fees and fund fees into consideration.
"A safe initial withdrawal rate today, assuming 50 percent stock exposure and minimal costs, might be 3.2 percent to 3.5 percent for a 30-year horizon," Reichenstein says. "If your mutual funds cost 1 percent, or you hire a financial advisor who charges 0.75 percent per year of assets under management, then you can reduce these safe initial withdrawal rates by 0.5 percent."
Old school: For a comfortable retirement, $1 million is " the number."
New rule: Try for $2 million to breathe easier.
"People used to think that if they had a million dollars, they were set," Nelson says. "But if you retire at 65, and live another 35 years, a million won't cut it. To net $5,000 a month after fees and taxes, you have to pull out $75,000 a year, or 7 percent. That isn't sustainable."
Old school: You probably can retire on the income numbers projected on your 401(k) statement.
New rule: Don't coast on the wisdom of footnotes.
"The projections included in 401(k) statements are kind of dangerous because they don't take into account real-life variables," Nelson says. "But people fixate on this estimate and they think, 'Oh, this statement says I can make it through retirement.' The reality is, you don't know how they arrived at that number." In the absence of the underlying methodology, it's best to take that footnoted projection with a huge pinch of salt, Nelson advises.
Old school: Compound interest is magic. Invest early and watch from your easy chair as your investments grow.
New rule: Compound interest sure helps, but experts rarely calculate the compound-deflating inflation, fees and taxes.
Compound interest, in a vacuum, does drive results, Nelson says. But in the real world, where you and your portfolio live, inflation, fees and taxes grind down the actual power of compounding. It's not magic, and it's not a free ride.
Old school: I can retire on my inheritance.
New rule: That works only if your parents die on schedule and don't leave a pile of medical, legal and other bills behind.
Don't assume you will inherit a pot of cash, Nelson advises. If there is a pot of cash, it must be carefully managed to ensure that it sustains quality of life for the generation that earned it, plus, if possible, a legacy gift for the next generation.
Old school: Formulas work. They're math, aren't they?
New rule: Simple math yields simplistic results. The real world is more complicated.
Traditional wisdom is based on historical returns over several mid-century decades that, in retrospect, were remarkably drama-free, advisors say. "But lately, the frequency of bubbles and crashes have been lots more destructive. Just following basic arithmetic rules don't apply," Ikeme says.
Add the bloodless speed of trading by algorithms, institutional investors and hedge funds, and individual investors face nothing but undertow, he says. "You can't beat the market by being smart. We're way past that," he says. Your best bet: Turn those automated systems to your advantage withtarget-date funds that adjust risk for you, he says.
By Joanne Cleaver | U.S.News & World Report