I often hear a comment from gen y's and x's that they don't count on getting social security benefits. I understand their doubts, but quickly add my opinion that social security will be available. And significantly, that it is likely to be an important element of their retirement income.

My point isn't that social security benefits won't change, there are a number of proposals being floated by both parties, rather that at this stage social security is a societal and cultural obligation the likes of which can not be easily changed.

When I model peoples retirement income, it is immediately evident that social security income is critically important for virtually everyone. Of course, there are those persons that have a large amount of wealth and naturally social security is insignificant for them. What is surprising is how much an impact social security income means for many of us that are considered wealthy. I use the words “critically important” to convey the importance of probability of success in retirement. Retirement projections are just that, a projection with an effort to determine the probability outcome (high, medium, low) that the income stream will sustain a certain level of consumption over the life times of the person(s). Take out social security income and the probability for maintaining most people life style drops precipitously.

I suspect that many people have never looked at a reasonable projection of their retirement life. Simple calculators don't provide a very accurate picture. A recent study highlighted the enormous disparity in outcomes when testing many of the online calculators. Its worth some effort to get a reasonable projection. You don't need to (and shouldn't) sign up for an expensive financial plan to arrive at this. I do this for a nominal flat fee.

Take the financial literacy test. Here's a suggestion, ask your older kids to take the test. It's only six questions. This is a fun and easy way to engage your older children on the topic of financial knowledge.

http://www.usfinancialcapability.org/quizzes.php

This quiz was put together by the FINRA Investor Education Foundation, and launched in 2009. Input was also provided by the Department of the Treasury and the President's advisory council. The purpose was to create a benchmark of basic financial literacy across the U.S. At six questions, this quiz isn't going to delve into lots of subject areas. But, why not start here. You'll have fun seeing where you rank. After completing the quiz you'll get a score (number correct), an explanation of the correct answers. You can see how you compared with averages nationally and from each of the states.

The most important element in the quiz is whether people understand the significance of compounding. Both debt and investments have interest rates that compound over time. Making investments early allows compounding to work to our benefit. Allowing debt to accumulate early ends up straining our future standard of living (if not sinking the proverbial boat).

And that's why this is such an important topic for our kids to learn.

This isn't an article about the financial stability of the social security retirement trust. When asked, my opinion is that the trust fund will be funded, one way or another, such that it will provide benefits in line with those provided today. And, that it will work for everyone contributing into the system.

Rather, this article is about how we each determine when to start our own benefit. Most people are aware of the “window” to begin benefits as early as age 62, and as late as age 70. The most common question I get is, what is the break even date given that our benefit at full retirement age (66-67) will be decreased for taking it early and increased for taking it later. I tell people that's a good question, but actually this question overlays another more important question. How long will you live? That's not a flip question. We need to spend some time, and honest assessment, to at least come up with a guesstimate. If you're having trouble answering that I suggest a longevity test that you can take. You can factor the outcome from that with your thoughts.

How long will you live is just one important factor when considering when to start taking social security. There are a number of personal situations that affect this decision. In fact, there can be thousands of permutations used to determine the optimal strategy for maximizing your social security benefit. But, the important point isn't just that you determine the maximum strategy. For most people, social security benefits are an important income stream throughout retirement. So, the question to ask is how does this fit in with everything else? That's an interesting discussion I'd be happy to have with you.

In part one of this topic I outlined the danger for target date funds at the later stages of your working life. In summary, after you've accumulated a meaningful amount of money your investment risk increases simply because the amount of money at risk is much larger and the timeframe to recover from a loss is limited. Target date funds do not account for the present state of the market in determining how to allocate the investment account at any time. Their simply following a preset “glide path”.

In part two I want to direct your attention to how target date funds are used in retirement. There are two different but interrelated goals for investments in retirement. First, provide a source of income, while second, maintaining (or building) wealth. On the one hand we want to create a consistent income stream for daily living. We want that income stream to be sustainable throughout our whole retirement (end of life). On the other hand we want to control the volatility of the account. Keep it steady. We don't want big ups and downs in the balance over time.

The problem is that while it may seem that the two goals are consistent, (steady income & steady balance), in fact pursuing both can be self defeating if you're relying on a target date fund. You see, most target date funds are concerned with just one aspect, controlling the volatility of the balance. It's not concerned with how to ensure there is a steady income stream over your lifetime.

Here's the important point. Creating a consistent income income stream and managing the account balance are two separate tasks. They are interrelated, and each needs to be managed properly to achieve success. The target date funds usually rely on bond funds to provide a steady (low volatility) account balance. As we learned in part one of this article, it does that without any consideration for the present state of the market. During retirement the target date funds simply assume that the bond funds will have low volatility and hence protect against major downturns in the market. In addition to that, they also fail to consider how the rate of return of the fund will support an income stream that most people want to be consistent over their entire lifespan.

In real life we need to manage and accept an appropriate level of volatility in our account balance in order to maximize the longevity of the income stream. Done properly, the account balance should be exposed to various investment options in order to capture returns in excess of bond funds for the very reason that bond funds may fail to provide the growth needed over your lifetime.

I'll end on this last note. Bond funds are often considered to be conservative (safe) investments with low downside risk. In fact, they can be subject to major and extended downturns. While individual bonds offer a degree of safety since they actually mature, target date funds are most commonly utilizing mutual funds with no termination date. If (when) bond yields rise in the future, the value of the bond fund shares will decline. This decline shows up in your account balance. We can only sustain consistent income withdrawals if our investment strategy achieves the level needed to extend our withdrawals to a reasonable life span.

It takes some thoughtful effort to understand how we are going to fund our retirement. It's worth the time and effort to understand this sooner than later.