If you're the type of person who can't stomach horror movies, stop reading now. To those thrill-seekers in the audience, I promise you won't be disappointed. Our horror flick is called Wall Street Stalker and stars an unassuming investor gripped by terror as his portfolio -- and his dreams -- are mauled beyond recognition by the stock-market slasher. But like most Hollywood vehicles, there can be a happy ending to this tale if our investor makes some simple lifestyle changes and sacrifices. The film opens in 2000, and our 45-year-old investor has laid aside $500,000 in his retirement account. He's putting away an additional $10,000 every year -- that's 10% of his $100,000 pay. His employer is tossing in a 3% match. And he knows that at 65 he can count on $12,000 a year from Social Security. His investments aren't too aggressive, for the time, at least. He's willing to take enough risk so that he earns a return of 10% a year. All this has put him on a course for early retirement in 10 years, according to the retirement planner on our site. The projected median value of his retirement account is $951,874 to $1,047,465 in 10 years. And that translates into retirement income of $81,019 to $92,010, at a minimum about 80% of his current salary of $100,000 a year. Unless inflation kicks up a storm, that seems sufficient to this investor. (All amounts are in current dollars, so the rate of inflation is a big unknown.)
Is It Safe?
All these figures are just projected medians. Our investor knows that the actual results might be better -- the retirement planner says the account could be worth as much as $1.75 million in 10 years -- or worse. In the heady days of 2000, though, this investor doesn't spend a lot of time worrying about that nightmare scenario. Until the nightmare comes true, sinks its teeth into his portfolio and doesn't let go. The retirement planner had calculated that the worst drop this portfolio could suffer, in the face of a year as bad as the worst in the last 75 years, would be $103,979 in a year, or about 21%. And that, unfortunately, is pretty much the kind of worst-case market this investor faced beginning in 2000, when the Standard & Poor's 500 stock index fell 10% and the Nasdaq Composite plunged 39%, and both kept falling into 2001 and 2002. By the time that the summer of 2002 arrived, our investor's portfolio had lost 50% of its value. Instead of $500,000, he had just $250,000, and his long-term investment plan was in ruins. Oh, and to add to the injury, everyone now says that he'll be lucky to earn 8% on his money annually over the next decade. Better forget about those 10% gains. OK, can this investor wake from his nightmare and recoup the 2 1/2 years and the $250,000 that he's lost?
It's Only a Movie
Believe it or not, there is good news. While the future will almost certainly include fewer of the fantasies that were all too easy to indulge in during the last days of the bull market, it can be reasonably comfortable and reasonably self-indulgent. I'm not offering any magic formulas here. No short cuts. No get-rich-quick alternative investments. The secret to repairing any portfolio lies in saving more, working longer, getting by on a little less after you retire and getting the highest return possible on your investments now that's commensurate with a reasonable amount of risk. Let's look at the alternatives, all of which assume 8% annual returns instead of 10%. He can work longer. Working until 2019 gets the job done. Without any other changes, working an extra nine years produces roughly the same retirement income (in current dollars) of $77,430 to $89,169. The value of the retirement account in that year is $784,420 to $875,894, which still lags the value he projected in 2000 but is at least in the same ballpark. That's not the "Work 'til you drop!" that the worst of current headlines say is in store for us, but it does mean that instead of retiring at 55 in 2010, our investor now retires at 64 in 2019. That's probably about the age at which our investor's parents retired, but it's a disappointment for anyone anticipating an extra 10 years of retirement. He can save more. Say, $20,000 a year on a tax-deferred basis instead of $10,000. It chops a few years off, but not as much as you might think. The power of compounding has much more effect on the end value of a retirement portfolio than any increase in the savings rate. Saving $20,000 instead of $10,000 a year enables our investor to retire in 2016 instead of 2019. But you can also put the power of compounding to work on the savings side of the equation. If instead of contributing a straight $20,000-a-year -- an extra $10,000 each year plus his original tax-deferred $10,000 -- our investor increased his contribution to his retirement account to $20,000 and then upped that lump sum by 6% a year, he could retire with essentially the same annual income of roughly $73,121 to $81,119 in 2015 instead of 2016. That's a compromise, of course. Our investor is trading 6% of current income that can be used for current consumption for a year less of work at the end of his career.
Retirement planning is all about the art of finding the best compromise for each individual. For example, how about the person who would like to keep working at something -- new career or old -- after official retirement? My father, for example, worked part-time for a good 10 years after he retired, doing yard work for what he called the "old people" in the neighborhood. It kept him active and outdoors and helped him become the information center of his neighborhood, a role he continues to relish. It doesn't take much part-time retirement income to make a big difference in an investor's retirement plans. If our investor, for example, could manage to add $15,000 in part-time income (after factoring in any loss of Social Security benefits), then he could retire on $77,795 to $87,470 in annual income in 2014. By using the power of compounding, saving more, adding to those savings with time and working part-time, I've been able to come up with a retirement program that replaced most of what our investor projected in 2010 retirement income without keeping him working until 2019. But you've probably noticed that I've cheated a little along the way. Our investor is now living on $77,795 to $87,470 instead of $81,019 to $92,010. That's a drop of somewhere around $4,000 at the bottom and top of the scale. That's real money. No doubt about it. And it should be enough real money to start you thinking about another post-bear market retirement trade-off. The 80% figure that's a popular measure of how much of your pre-retirement income you'll need in retirement is largely an arbitrary figure. It doesn't take into account individual circumstances, e.g., if our investor has paid off his mortgage, his need for income will be less. And it doesn't include the possibility that some people will be willing to trade retirement income for retirement time. For example, if our investor is willing to get by on less -- on $72,952 to $79,895, or about $6,000 to $9,000 less a year -- he can cut his retirement date back to 2013. And that last compromise means that instead of retiring in 2010, our investor will retire in 2013. The time he's lost in his retirement plans to this bear market is with these compromises roughly equal to the duration of the bear market, assuming that it ends this year.
Crash Changes Our World, Doesn't End It
I'd like to make two final points about the retirement plan that emerges after all this juggling. First, it requires making do with less here and saving more there and working longer here and working part-time there, but the final effect of the whole is well short of catastrophe. The pain of this bear market has been real -- and I'm fully aware that some investors and workers who had their retirement savings bound up in companies such as WorldCom have done far worse than the 50% loss that I hypothesize. I'm rooting for the courts to do as much as they can to help these people. But that said, I think that the vast majority of us need to recognize that this bear market, or crash, or whatever term you prefer, hasn't been the end of the world. Also, I believe that the post-bear market world will be radically different. That includes the stock market, of course, but I'm referring more to the economy and society in general. People will be working longer full-time and they will participate longer in the workforce part-time. That will change career patterns and family structures in ways that it's too early to fully grasp. It will certainly have a huge effect on the generations of workers who follow the baby boomers, because those boomers won't be rushing to leave the workforce. There's likely to be quite a logjam ahead, never a good situation for intergenerational politics.