Are You in the Retirement Danger Zone?

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A bad investment can be a serious wealth stealer, but as much as it matters how much you lose, it can matter equally when the loss occurs. As you approach or enter your retirement years, declines in the value of your portfolio can be especially devastating.

"Dollar-cost averaging" describes how you can benefit even when the market goes backwards -- if you don't need to withdraw your money anytime soon, and continue to regularly invest when prices are low. Let's say you invest $500 a month in a mutual fund. When the fund is $15 a share, you're buying more share than when it's $20. Then when the market comes back and your fund hopefully goes up, you own more shares, so your gains will be bigger.

However, dollar-cost averaging assumes that you are in the accumulation phase of life and will keep putting in fresh money toward retirement for awhile. It also assumes you have enough time before you'll need the money to allow your portfolio to rebound from any significant downturns.

If you're in the distribution phase of life and are taking funds out of that mutual fund, what you run up against is the phenomenon of "reverse dollar cost averaging." If you are taking out $3,000 a month to help cover your retirement expenses, and you have to sell shares at the lower $15 apiece price, you'll need to sell more of them, which means you won't be holding them when they recover. And sales like that can cause you to run out of money quicker.

Enter the Retirement Danger Zone

The retirement danger zone begins when you get within 10 years of your scheduled retirement date, and lasts for the remainder of your life. Any losses you take during this phase can dramatically affect the quality of your later years. Many older people who experienced such pains to their portfolios in 2007 and 2008 found that they couldn't afford to retire on schedule, or had to go back to work to supplement their income. According to the Federal Reserve, the median net worth for Americans ages 55 to 64 went down approximately 33 percent from 2007 to 2010.

Stock indexes are hitting records again now, and enthusiasm may be causing some people to forget just how fast the market can turn. It is critical for those in the retirement danger zone to begin to reallocate more of their retirement funds toward rock-solid products that remove any risk of market loss. Below are some places you could reallocate money from stock and bond mutual funds to places with much less volatility. The old rule of thumb is that you will sacrifice decent growth to preserve your principal. In many cases, that is true.
  • Savings accounts have a pitiful rate of growth and should be used strictly for a liquid emergency fund. The principal is protected and FDIC-insured.
  • Money market accounts are usually very safe and offer a higher -- but still low -- growth rate than savings accounts. They are very liquid.
  • Fixed annuities offer better rates than above but are not liquid. Annuities come built in with an early withdrawal penalty that can wipe out modest gains if funds are needed sooner than expected. Don't confuse a fixed annuity with a variable annuity that tracks the markets and hence are subject to large losses. Variable annuities are not a place for retirement danger zone money.
  • Certificates of deposit offer more interest than savings accounts but take away liquidity. CDs are for defined periods from 30 days to a number of years. The longer you agree to not touch the money, the more interest the bank will pay.
  • Fixed indexed annuities are a hybrid of fixed and variable annuities that will protect your principal in down markets but allow you to participate in a portion of the gains in up markets. You can also buy a lifetime income rider that will assure a certain income for you and your spouse's lifetime. They are illiquid for the first seven to 10 years, depending on the product. They could be a great place for IRA funds to grow safely.
  • Cash accounts allow people to deposit funds with some life insurance companies on a fixed rate of return that is usually more attractive than what banks offers. When banks are paying 0.5 percent, some of these accounts pay 3 percent. These accounts are generally liquid -- but if you withdraw from the account, you must withdraw the entire balance.
John Jamieson is the best-selling author of "The Perpetual Wealth System." Follow him on Facebook and Twitter.

10 Ways to Reduce the Cost of Retirement
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Are You in the Retirement Danger Zone?
Eliminating your mortgage is one of the best ways to make retirement more affordable because it removes a sizable monthly bill. While you'll still have to pay taxes and maintenance costs for your home, those expenses are likely to be a fraction of your mortgage payments.
Once your children are independent, you will likely no longer need a several-bedroom house in a good school district with a large yard that can be expensive to maintain. Consider downsizing to a smaller home in a less-expensive neighborhood, and add the proceeds of the sale to your nest egg.
Where you live plays a big role in how much you pay for food, taxes and a variety of other services. Moving to an area where the cost of living is significantly less could allow you to spend down your retirement savings more slowly.
If you and your spouse commuted to separate places each day, it is likely that you each needed a car. In retirement, you might be able to get by with one car, thus eliminating the insurance, gas and maintenance costs of the second vehicle. In walkable communities with good public transportation, you may even be able to get by without a car in retirement.
In retirement, income tax will be due on withdrawals from traditional 401(k) and individual retirement accounts, but you can space out your withdrawals to avoid a hefty tax bill in a single year. Prepaying income tax on some of your retirement savings using a Roth IRA or Roth 401(k) allows you to avoid a big tax bill in retirement.
Investing in high-cost funds reduces your return. Minimizing investment costs is especially important for retirees who are living off income from their portfolio. In this case, selecting the lowest-cost funds that meet your investment needs translates to more money in your pocket.
There are significant penalties if you withdraw money from your retirement account too soon or too late. There is also a reduction in benefits if you sign up for Social Security early, and a late enrollment penalty if you delay signing up for Medicare Parts B and D. Pay attention to important retirement deadlines to avoid paying more than you need to.
Health care is likely to be one of the biggest and least predictable costs you will face in retirement. But there are some things you can do to control your health costs. Consider purchasing a supplemental policy to Medicare to fill in some of the gaps and cost-sharing requirements traditional Medicare doesn't cover. Also, shop for a new Medicare Part D plan every year to make sure you are getting coverage for your medications at the best price.
Retirees have the luxury of being able to travel whenever they want. Traveling is often less expensive if you avoid major holidays and school breaks, and most tourist destinations will also be less crowded.
One of the major perks of growing older is getting discounts at movies, museums and restaurants. While some senior discounts are well-publicized and open to everyone old enough to have an AARP card, others are available only to those who ask. A little research can add up to big savings if you’re willing to admit your age.
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