“Early retirement behavior matters most. The first 5-10 years of retirement have an outsized impact on long-term success. Spending less during these years provides a better likelihood of positive outcomes over the retirement horizon.”
From Savings to Income (AIER 2014)
Everyone knows that returns matter, but when you experience those positive and negative returns matters greatly. In other words, the sequence of returns matters.
Let’s say you retire just before a 10-year period of market decline that is followed by a 10-year rise in market value. You might consider the average market return to be fine, but this sequence of returns would actually be quite detrimental to your lifetime retirement income.
On the other hand, let’s say you retire just before a 10-year period of increases in stock market value that is followed by 10 years of falling returns. The average return is the same as the first situation, but because of the different sequence, you’ll be in a much more favorable position.
Like many Americans, my 35-year old brother has yet to save anything substantial for retirement. After years of brotherly pestering, I’ve finally convinced him it’s time to start. I figure that with 30 years until age 65, he still has time to accumulate a decent nest egg. As a starting point, we looked at an online retirement calculator. According to the calculator, if he saves $2,000 per year, he could hypothetically have about $200,000 by age 65. The calculation included a chart with a pleasing upward trend, as seen below:
This steady rise in savings is based on historical average returns. What happens, however, if markets lag? Read more
ING’s advertising campaign suggests that workers need to save millions of dollars in order to retire comfortably. You know the ads, where people lug around target savings amounts, all upwards of $1 million. It seems like such a burden to achieve these numbers. But recent research by Dr. Marlena Lee of Dimensional Fund Advisors suggests that maybe the retirement hurdle isn’t so insurmountable.
Dr. Lee’s research suggests that low- and middle-income households that target a savings rate between 2 and 11 percent may actually save enough for retirement. This is encouraging news for workers that will be reliant on 401(k) balances in retirement.
Dr. Lee starts by defining a replacement rate: the percentage of gross pre-retirement income that is replaced in retirement. If you earned $50,000 per year before retirement, a $25,000 annual pension would represent a 50 percent replacement rate. Dr. Lee finds that in order to achieve replacement rates that maintain living standards through retirement, the average household needs to save about 11% per year during working years. But that savings rate varies by household income. Read more
College grads often wonder whether to pay down student debt first or to save for retirement. Financially savvy folks recognize the need to save for retirement sooner than later, but they also know the detriment of carrying a large debt burden.
To answer this quantitatively, you must compare your expected rate of return on retirement savings and your student loan interest rate. If you expect to make 8% a year on your retirement portfolio but your student loan interest rate is only 5%, it would be advantageous to maximize your retirement savings and pay the minimum on your student loan debt.
Consider a $10,000 student loan at 5% interest, with a minimum monthly payment of $106.07. We’ll assume you have $300 per month to put towards paying down that loan or investing in a retirement account with an 8% annual return.
If you make the minimum payment on your student loan debt and save the remaining $193.93 for retirement, at the end of 10 years your student loan will be paid off and you will have $35,480 in your retirement account.
If you put all $300 per month toward your student loan debt, your loan will be paid in 3 years, leaving the full $300 to be put toward retirement for the next 7 years. At the end of 10 years, you will have $33,654 in your retirement account.
Even with this sizable difference between the interest rate and annual return, the final balance differs by only about 5%.
There are 3 big problems with this simple answer:
Investors approaching retirement often have accumulated a substantial “nest egg” (held in a 401(k) or in other accounts) intended as a source of retirement income. If they decide not to purchase an immediate annuity of some type or arrange for other financing, they face the question of how to effectively “annuitize” that nest egg themselves through some type of systematic withdrawal plan.
William Bengen presented what has come to be known as the 4% Rule in 1994. This nest egg withdrawal rule of thumb suggests that retirees can safely draw four percent annually from retirement assets, adjusting upward for inflation. For example, a retiree with a $1 million nest egg could safely draw an inflation-adjusted $40,000 per year in retirement. Since this seminal article, there has been significant study on the efficacy of this rule. Several detractors have found it to be too simplistic. Nonetheless, many financial advisors have adopted the rule as a starting point.
Nineteen additional years of monthly return data have been recorded since the Rule debuted. If a retiree had followed the 4% Rule and invested 50/50 in stocks and bonds, how would his nest egg look today? Perhaps this analysis can help shed some light on the recent effectiveness of the Rule.
To answer this question we examine simulated investment periods. It’s important to remember that any analysis based on historical returns relies on a limited amount of data. There have been only four independent 20-year return windows since our investment returns data begin in 1928.
This week’s episode of PBS Frontline is all about the state of retirement in the U.S. Long story short? Things aren’t looking so hot. People are overwhelmed by investment choices, management and sales fees are eating into portfolio returns, and most people are confused about how much to save–and how to save it–to begin with. No wonder so many Americans are in shaky financial shape for their golden years.
Frontline’s Martin Smith says that many of these issues can be traced back to a single source: an untrustworthy financial services industry.
Eighty five percent of all financial advisers and financial planners are really just brokers or salesman. Their incentive is to sell you a product that makes them a higher commission, not necessarily a product that maximizes your chances of saving more. Only 15 percent of advisers are “fiduciaries” — advisers who by law must operate with your best interests in mind.
In fact, as AIER reported last summer, a recent study by the National Bureau for Economic Research suggests that many financial advisers put their own best interests before those of their clients. But that’s not to say that everyone has to muddle through hard investing decisions on their own, Lord of the Flies-style. Armed with a few strategies, you can track down financial advice that’s reliable and ethically sound–and begin preparing for retirement responsibly.
Here are a few suggestions to help you find on-the-level financial advice.
1. Check credentials. Look for a Certified Financial Planner (CFP), Chartered Financial Analyst (CFA), or Chartered Financial Consultant (ChFC). These credentials emphasize a strict code of ethics, and certification requires that consultants pass rigorous exams.
Find out whether you are talking to a broker or an adviser. The primary job of brokers is to sell financial products made available by their company. Advisers provide ongoing management of a portfolio. It’s also a good idea to confirm that the adviser has a clean record through the U.S. Securities and Exchange Commission and state securities agencies. Read more
Most of us are aware that we ought to be saving for retirement. What’s not so clear is how much we’re supposed to save.
One of Daily Economy’s readers, keh211264, responded to Wednesday’s post on retirement savings with a question about this issue:
Are there some data that suggest how much savings one should have for a retirement that is in line with one’s accustomed living standards? In other words, if I’m accustomed to living on a gross annual income of $35,000, should I save 10 times that amount to be able to retire at the Social Security benefit age? What would that mean in terms of a yearly savings bogey? Some information like this might help people see a target to shoot at.
I turned to one of my colleagues for some quick pointers on planning responsibly for our golden years.
Great question. While there is no simple and direct answer to your query, you may be able to get a better sense of where you stand now vs. reaching your retirement bogey by thinking about how you would answer the following questions: Read more
Fifty-seven percent of U.S. workers have less than $25,000 saved for retirement excluding home equity and defined benefit pension plans, The Wall Street Journal reported on Wednesday. And 28 percent of workers have less than $1,000 socked away.
Why do many Americans today have so little money saved for their golden years? The Employee Benefit Research Institute (EBRI) offers several insights.
The number one reason workers gave for not contributing (or not contributing more) to their employers’ retirement plans was the cost of living and day-to-day expenses. Forty-one percent of workers who were eligible for such plans said that everyday costs wound up pushing retirement contributions to the back burner.
Debt may also be a major factor for people who are struggling to save for retirement. Fifty-five percent of workers and 39 percent of retirees reported having a problem with their level of debt. Read more