The 12 Pitfalls to Avoid When Retiring from BP, by Phil Multop, CPA, CFP - are highlighted in our letter campaign, launched in September 2007. The 12th and final letter will be released in March 2008 -- stay tuned for a very special offer!"
PITFALL #1: Investing for the Wrong Time Horizon
PITFALL #2: Not Locking In Your Gains Before Converting to an IRA
PITFALL #3: Owning Too Much or Not Enough BP Stock
PITFALL #4: Failure to Understand the Stock Market
PITFALL #5: Thinking Tomorrow Will Be Just Like Today
PITFALL #6: Ignoring Inflation When Planning for Retirement
PITFALL #7: Not Being Ready When the Time Comes
PITFALL #8: Retiring Without an Investment Strategy
PITFALL #9: Not Being Well Diversified
PITFALL #10: Coming soon!
PITFALL #1:
Investing for the Wrong Time Horizon
If you are retiring at age 55, you could potentially live another 30 years or more. If you want your money to last as long as you do, you need to think long term.
When you were younger you took more risk because you had more time to make up for possible losses. Now that you are closer to retirement, or perhaps already retired, your instinct is to keep your money close to you in the form of short-term and very low risk investments. The stock market seems scary because of the volatility. You tell yourself that you can’t afford to lose anything.
It’s true you should not take the same amount of risk that you did when you were younger, but remember, you might have 30 more years of life ahead of you! It’s true that as you reach retirement age it’s important to examine how much risk is appropriate and what your time horizons actually are. But investing for the wrong time horizon is a major pitfall that BP employees should avoid. You have a healthy nest-egg built up in your 401(k) – make sure it continues to work hard for you once it is converted to an Individual Retirement Account (IRA).
Most BP employees think of their 401(k) as a growing account; money that is invested for growth and accumulation. Generally speaking, that is true. But the mistake is thinking that once it’s converted to an IRA at retirement it should stop growing and be “put under the mattress” so-to-speak. That’s where Pitfall #1 becomes apparent. Yes, you should protect your capital, but don’t make the mistake of investing for time frames that are too short because you will miss out on the earning potential you need in order to make sure your money lasts a lifetime.
It is a balancing act – to invest for the right time horizon AND protect your capital. With the proper guidance you can maximize your earning potential AND reduce your risk and volatility. You can receive an appropriate income stream AND invest for a lengthy time horizon.
At Multop Financial we have an Asset Allocation model for BP employees that handles these very concerns. We can guide you through the rollover process and work with you to create an investment plan that ensures you are investing for the RIGHT time horizon.
Pitfall #2:
Not Locking In Your Gains Before Converting to an IRA
Whether you have realized it or not, all these years of contributing to your BP 401(k) you have been utilizing a very effective investment strategy called “Dollar Cost Averaging”. This means, you have consistently been putting money into the stock market regardless of market conditions, buying at low times and at high times. This technique averages out the cost per share of the stocks you are buying, which ensures that you are not buying only at the high times. Just like the bargain bin at the department store, you want to buy when the prices are low (assuming it’s a quality stock). When you contribute to your 401(k) over time, essentially you are hitting the bargain bin every now and then, which is a very good thing.
Now that you are at the point where you will no longer be contributing (dollar cost averaging) you want to make sure that you lock in some of those gains. Meaning, find out which stocks (mutual funds) you purchased from the bargain bin and depending on their current value, you might want to sell them and “lock in your gains”.
Not locking in your gains before converting to an IRA is a major pitfall you can avoid by doing some planning ahead of time. It’s a case of either “good timing” or “bad timing”. If you have decided on a retirement date and, oops, the market takes a dive just when you’re planning to convert to your IRA, that’s a major disappointment. However, you have many options within your BP 401(k) where you can park your money as you get very close to your conversion date. It’s true that if you have locked in your gains and the market goes up, you may have missed out on some earnings. BUT, if the market takes a hit, you are sitting pretty with preserved capital. We all know that the stock market is a volatile animal. Nobody knows what the market will be doing in six months, one-year or even tomorrow. If your retirement date is approaching, you don’t want to be the unlucky person who converts their 401(k) when it is at an all time low. This is called “Pre-Retirement Planning”.
Many BP employees don’t realize they can have input as to the types of stocks (mutual funds) being purchased with their 401(k) contributions. At Multop Financial, we have the complete list of BP 401(k) options that we can share with you. Armed with this list, and some sensible information about where our economy is headed in the near future, you could avoid pitfall #2, or at least minimize your risk. Call our office and set-up a time to stop by and review the list of investment options available to you. There is no charge for this service.
At Multop Financial we can guide you through the Pre-Retirement Planning process and easily handle your rollover paperwork. We do it all the time. Our job is to give BP employees peace of mind as their retirement date approaches, and long after. In fact, it’s our passion.
Pitfall #3:
Owning Too Much or Not Enough BP Stock
Since you have been working at BP for many years, it is completely understandable that you might own a considerable amount of BP stock. On the flip side, maybe you think you should own more than what you do. This is a dilemma that many employees face when they work for an organization with wide national and global recognition. There is a sense of loyalty (after all, you have worked hard every day for this company) but at the same time, you know in the back of your mind that too much of anything equals “too many eggs in one basket”.
At Multop Financial, we believe that BP stock could be a viable part of the equation in your retirement portfolio, as long as you consider it to be part of the energy section of your total allocation. With that said, you also need to examine the other stocks and funds within your energy portion to make sure that you aren’t top heavy in oil. Alternative energy sources and natural gas would also contribute to a nicely balanced energy section. But the key is to remember that energy should be only a small part of your overall allocation. The actual dollar amount or number of shares owned within each section will depend on your total portfolio value. An example to illustrate this would be if we took a 58 year old retiree with a portfolio value of $750,000. Our moderately conservative asset allocation model might dictate that approximately 5% of the total portfolio should be invested in energy. That would mean that $37,500 should be nicely balanced within the energy sector, of which a portion could be BP stock.
Hopefully you can see that an appropriate amount of BP stock could be beneficial in your retirement portfolio but many factors needs to be considered. That’s why a professional financial advisor (preferably a Certified Financial Planner bound by the ethics of the Board of Standards) can provide valuable advice on how much BP stock is too much and how much is not enough based on your personal goals and risk tolerance levels.
At Multop Financial we have dedicated a considerable amount of our staff’s talent and our firm’s resources to fine-tuning the portfolio analysis and management services we offer BP employees. We can provide a detailed historical breakdown of BP stock and give you our opinion of where the stock might be heading. We can take your current allocation and give you a Morningstar analysis to help determine if you own too much or not enough energy and specifically too much or not enough BP stock. Call us for that information – we would be very pleased to offer you a complimentary review with absolutely no obligation.
Pitfall #4:
Failure to Understand the Stock Market
Here’s a concept – you don’t need to understand how the market works. Why? Because the market is going to do its thing, year after year, regardless of how well you understand it or not.
One day the newspaper headlines read “DOW Soars to Record High” and two days later the trail on the bottom of CNN says, “DOW Plunges to Seasonal Low”. How can anyone possibly understand how the market works? You only need to understand four things:
- Your life expectancy
- Your financial goals
- Your emotional reaction to media news about the stock market
- The experience level and competence of your financial advisor
We don’t mean to oversimplify this topic, but to be honest, nobody understands how the stock market really works. If someone tells you they do, you should walk away. The only thing we know is that historically speaking the market goes up. We also know that people have emotional reactions to money. The job of your financial planner is to help you manage time and emotions so that you can reach your financial goals.
So you are probably wondering why we talk about Asset Allocation, Time Horizons and all those other investing topics when we talk to BP employees about your retirement plans. It all comes down to managing time (your investment period), managing emotions (risk tolerance) and getting to your goals (how much money will you need to live the life you want). Of course, knowledge of the stock market and how it has functioned historically is important to your financial advisor. But as the investor, you should focus on your goals and feel secure in the fact that never in history has anyone lost money when they have been diversified in the market for a fifteen year period. Of course, past performance of the stock market is no guarantee of future results, but to think that ever since the stock market has existed, there has never been a loss in principle for an investor who had a 15 year time horizon. Now think about how old you are? I bet you have a 15 year time horizon, right? Statistics tell us that if you are 65 years old today, you will probably live another 21 years.
It is the philosophy of Multop Financial that in today’s economic environment, approximately 50% of your retirement assets should be out of the market in non-market correlated investments. That even furthers the case for not wasting your time trying to understand the market. Here’s our advice: Take the time to work with a financial planner who understands how to manage time, emotions and goals with appropriate asset allocations, including market and non-market investments. With your planner’s help develop a plan that works within your risk tolerance levels and allows you to reach your financial goals. Implement the plan. Enjoy life. And don’t watch the news!
Pitfall #5:
Thinking Tomorrow Will Be Just Like Today
Many people make their investment decisions based on what’s happening today – as if today will just keep on going, as if nothing will ever change. But change is inevitable. Look in the mirror and ask yourself if anything has changed over the last 15 or 20 years!
Basing investment decisions on what has done well in the past seems to be a common mistake that BP retirees make (unless we can stop them first!). Why do you think that is? Perhaps it’s the same reason many employees with 401(k) accounts make this mistake – you look back at what happened throughout the years while you have been building up your account and you think it’s been pretty successful, why not continue doing the same thing? But the truth is that today starts a new way of thinking. Generally speaking, as your retirement date approaches, you should be moving out of high growth mode into slow growth mode (in order to protect your gains and reduce volatility) which means tomorrow will not look like today and it won’t look like yesterday.
You know that handling retirement funds DURING retirement is different than handling retirement funds while you’re still working. But you might wonder how to make that adjustment. You need to think about how your needs will be different “tomorrow”. You might need to create an income stream to replace your monthly BP paycheck. You might need to reduce your market exposure so that the ups and downs don’t stress you out. You might need to allocate funds for additional insurance. If you plan to continue working after retirement from BP you might need to do some business planning to reduce your income tax. You can see how thinking tomorrow will be just like today could be a big mistake. It’s all about managing the changes, anticipating how life will be different and working with a professional who can guide you through the transition.
The first step to understanding what you’ll need tomorrow is easy – understand what’s happening today! Click here for an income/expense worksheet to help you understand your current cash flow. In our next mailing, we will show you how to take those numbers and estimate what you’ll need in retirement.
Thinking tomorrow will be just like today is a mistake. What can you do today to avoid this pitfall? Begin by understanding your financial position today, then start thinking about what “tomorrow” will look like. And take the time to develop a relationship with a professional advisory team to handle the mechanics of your money so that you can focus on living the life you want during retirement.
PITFALL #6:
Ignoring Inflation When Planning for Retirement
Ronald Reagan was quoted as saying, "Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man." We think your best body-guard against the damages of inflation during retirement is to take the time to understand how it works and make it a priority issue when planning for your retirement.
In our last letter we talked about how “Thinking Tomorrow Will Be Just Like Today” is a big mistake. Here’s one reason why – INFLATION. Most people underestimate the impact inflation will have on their retirement plans. Even at relatively low rates, inflation is a real thief of buying power over time. Ignoring inflation when you are preparing for retirement could have disastrous affects. Any financial planner worth his or her salt will automatically work inflation into the equation. But for the average person who is trying to get a handle on how much money they will need to retire may not realize the impact inflation has on the bottom line.
The Fourth Edition of the American Heritage Dictionary of the English Language defines inflation as, "A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services." Basically, inflation makes goods and services more expensive and decreases the value of your money. You might say to yourself that inflation has been mild for the last several years, and if the indicators are correct, we’re heading for a bearish-market which means low inflation rates. But when planning for retirement we need to think long-term. Remember our first letter on Time Horizon!? Inflation is a very serious risk for any investor because it reduces the real value of investment returns. If you earn 10% on your investments during a time period with 4% inflation, your true gains are only 6%. Because the inflation rate is difficult to predict, the most sensible approach may be to plan for a moderate rate and make adjustments as economic conditions change. In any one year, a few percentage points of inflation may not seem a serious problem. But, over time, continuing inflation can compound into a very large loss of value. This alone is good reason to work with a qualified financial advisor.
Last time we enclosed a Cash Flow Worksheet. Hopefully you took a few minutes to fill it out. Now it’s time to take those numbers and see how inflation will affect your financial needs. The math calculations on this worksheet will give you a basic idea of how much you will need to retire and still maintain your current lifestyle, taking into consideration the affects of inflation as well as any miscellaneous income you might receive from social security or business activities. Once you have completed the math, call us for some guidance on how to take the next step.
PITFALL #7:
Not Being Ready When the Time Comes
Robert Half, author and employment guru, once said, “There are some who start their retirement long before they stop working.” He could be referring to people with poor work ethics or he could be referring to the insightful strategy of planning and saving for retirement while still in your working years, 5, 10 and 15 years before retirement.
If you are NOT ready when the time comes, you could suffer severe and negative consequences during retirement such as being over-exposed to market risk, underestimating your cash flow needs, not knowing how to structure retirement income and worst of the worst – you could run out of money. However, not being ready when the time comes is a very avoidable situation. With a basic checklist and some professional advice, you can take simple steps in the time leading up to your retirement and reap the rewards of your planning efforts for decades into your retirement.
We realize that every individual and every family has specific and unique circumstances that need to be considered in the retirement planning process, but generally speaking, here is an outline that can serve as a guide to avoiding the pitfall of not being ready when the time comes.
- 7 Years Ahead: Analyze your financial situation and determine a retirement date
- 5 Years Ahead: Begin to transition your assets within the BP plan for less risk.
- 2 Years Ahead: Start preserving gains by moving some market assets to non-market investments
- 1 Year Ahead: Develop a comprehensive financial plan to verify budget, income & insurance needs.
- 6 Months Ahead: Review plan paperwork and do another asset allocation rebalance
- 3 Months Ahead: Prepare your retirement asset allocation for fund placement after rollover
- 1 Month Ahead: Request paperwork from the BP benefits department
- Retirement Date: Transfer the 401(k) and pension funds into your IRA
- Post-Retirement - 6 months: Review cash flow, make income stream adjustments if needed
- Post-Retirement – 1 Year: Comprehensive annual review
Remember that regardless of where you fall on this checklist, there is always the opportunity to catch up on tasks you might have missed. It is not uncommon for BP employees to be within one or two years of retirement before they start planning. That’s where our skills shine as BP experts; we know how to get you organized and caught up with all your planning needs. Start with our free consultation!
PITFALL #8:
Retiring Without an Investment Strategy
Asset Allocation - Risk Tolerance - Tax-Advantaged - Diversification
What does it all mean? You’ve heard these terms being thrown around in conversations about investing and retirement planning. Yes, these are factors that should be carefully considered when developing a sound strategy for retirement, but it doesn’t mean much if you don’t know what your retirement lifestyle will look like.
Investing DURING retirement is totally different than investing FOR retirement. The first task in avoiding this critical Pitfall of Retiring Without An Investment Strategy is to think about what you want to achieve during your retirement. Here are some questions to ask yourself:
- Will one or both spouses continue to work after “retirement”?
- If retiring early, how many years until social security kicks in for one or both spouses?
- Do you have other activities in your financial life that would require tax planning?
- Are you the type of person who can handle volatility, or do you need stability for peace of mind?
- Other than daily & monthly living expenses, do you have a handle on your spending, or do you need access to cash on a regular basis?
- What is your life expectancy (time horizon)?
- Is it your goal to leave money to your heirs, favorite charities or do you want to spend it all?
You can see where these questions need to be answered before a strategy can be developed. You might say your goals are to “generate income” and “not run out of money”. But how much income do you need? And how long will the money need to last? If the investment strategy does not fit the goals of the investor, the results could be devastating. Financial planners, like us, can do careful analysis, develop a plan and make recommendations for mutual funds, fixed investments and income producing products. But to do that, the most important information must come from YOU. After all the years of working and raising your family, what do you want your life to look like?
A well designed investment strategy is useless if it doesn’t fit the goals and lifestyle of the investor. Your financial planner should take you through a series of planning steps so that together you can develop an investment strategy with your goals at the core. At Multop Financial we have developed a set of Asset Allocation models that match the top five “lifestyles” we most commonly see. You may fit perfectly into one of those five, or we may need to tweak the strategy for your unique situation. Either way, getting to know what you want your life to look like after retirement is THE MOST IMPORTANT FACTOR of any investment strategy.
And don’t forget the years PRIOR to retirement. If you still have two, three, five or 10 years to go before retirement, an appropriate strategy NOW will get you there faster. Call us today and let’s look at where you are and where you want to go. It’s not just your money, it’s your life we’re talking about.
PITFALL #9
Not Being Well Diversified
Current stock market trends got you wondering “how low will it go?” It’s no fun to watch your accounts continually drop or have volatile movement during times of stock market downturns, especially as your retirement date approaches and your time horizon is shortening. The last thing you want to see is a shrinking portfolio balance just when you need the maximum value more than ever. Diversification could be your saving grace.
Although as a BP employee you have a wide array of fund-types to choose from within your 401(k) accounts (you should be examining exactly what funds you are in and choosing industries with less exposure to loss), those of you who are nearing retirement should also be considering ways to offset market downturns by use of diversification through non-correlated or negatively correlated investments. “Correlation” is the extent to which prices move in the same direction. “Negatively correlated” is when prices move in opposite directions.
In a traditional portfolio of stocks and bonds, non-correlated investment strategies can be used by investors to neutralize or counterbalance the losses when one or more of the assets fall in value at the same time. In order to do this, investors typically place between 20% and 50% of their total investment portfolio into alternative investments to protect the remainder of the portfolio from downside risk.
Everyday we work with BP employees to do this very thing. We have used this strategy for years, but in a market situation such as the one we are in now, the fundamental characteristic of minimizing downside risk is what makes this alternative investment strategy so appealing and effective. By using the non-correlated alternative investments we can seek to generate positive returns regardless of the direction of the market. Like any investment, there are risks involved, but diversification of this nature is known to increase your potential of overall success.
How can you avoid the pitfall of not being well diversified? Here are two things you should do right away:
- Look at the asset mix of your current holdings and make adjustments if necessary.
- Consider taking funds that are available without penalty or taxation and develop a non-correlated allocation.
While working with other BP employees, this is where we have proven our value. At Multop Financial we offer a complimentary consultation with no obligation. We can look at the existing holdings in your BP retirement accounts and give you ideas on how to take an appropriate portion of market-exposed assets and provide possible protection through non-correlated and/or negatively correlated investments.
Pitfall #10 coming soon!
 |
Securities offered through:
Pacific West Securities, Inc.
555 S. Renton Village Place, #700
Renton, WA 98055
Member FINRA/SIPC
|
Advisory services offered by:
Pacific West Financial Consultants, Inc.
555 S. Renton Village Place, #700
Renton, WA 98055
Member FINRA/SIPC
|
|
