Tax and financial advice from the Silicon Valley expert.

Why savings accounts and bonds aren’t enough for retirement

If Mom and Dad (or your parents or grandparents) lived through the Depression, chances are you heard them say, “You’ll be OK in retirement provided you only live on income from savings and bonds, but don’t withdraw principal”, and “Investing in the stock market is too risky for retirement.”

We are living in another age. Life expectancies have increased dramatically. Did you know the joint life expectancy of a non-smoking married couple at age 62 is 30 years? That’s a long time to make your savings last.

Meanwhile, the cost of goods and services generally keeps going up. For example, the cost of a first-class postage stamp on May 25, 1980 was $ 0.15, compared to $ 0.44 today (May 25, 2010.) If you retired today, your retirement fund would have to not only be sufficient to pay your current expenses but pay expenses at future prices thirty years from now.

The value of principal in savings accounts and bonds doesn’t grow to keep up with this inflationary challenge. Also, interest earned from savings and bonds probably won’t be enough to keep up with your cost of living, so chances are you will find your retirement fund consumed within a few years.

In order to keep up, there has to be an inflation hedge. The most convenient and liquid way to do this is with marketable securities, such as stock and real estate investment trusts. Real estate can also be an inflation hedge, but isn’t liquid (can’t be sold instantly) may require management that is not appealing to some investors. From January 1, 1927 through December 31, 2009, the compound return of the U.S. stock market was 9.7%, long-term government bonds returned about 5.4%, U.S. Treasuries returned about 3.7% (about the interest rate for certificates of deposit), and the consumer price index increased about 3.1%.

Long term, we can’t afford NOT to invest in the stock market.

Most of us need the help of a financial planner to maintain the discipline to get long-term returns. From 1990 to 2009, the return for the Standard and Poors 500 was about 8.2%, but the average investor earned about 3.17%. (Inflation was 2.8%.)

As the Baby Boomers enter their retirement years and we see the pressure on the Social Security system, all of us need to be aware of the challenges we face in funding our retirements and plan accordingly.

Craig Martin, C.F.P. and I discussed this problem in a Financial Insider Weekly interview posted at Watch it and make better plans for your retirement.

Tax and financial advice from the Silicon Valley expert.