A reader asks:
When we read articles about “How much you should have saved by age X”, should it not be “How much income you will be earning with savings Y”? Here’s my scenario: Mid 30s, worked at a public University for 11 years and left to take a job in the private sector. I have a pension at the University with a guaranteed fixed income and just starting a new 401(K). Total retirement savings doesn’t help me know if I’m on pace. Assuming a presumed 5% withdrawal rate and 8% 401(k) growth rate, wouldn’t a “calculated retirement payout” that can include things like pensions and Social Security be better than “make sure you have $1M by 50, etc.”?
Remember this commercial where people are walking around carrying their retirement number:
I need $500,000 to retire. Well I need $1 million. I couldn’t retire on anything less than $5 million!
I get the idea.
Setting goals and benchmarks is a crucial aspect of long-term planning. After all, how can you plan for the future if you’re unsure about where you want to end up?
However, retirement planning can be quite challenging due to the multitude of unknown variables involved, particularly for individuals in their 20s, 30s, or even 40s.
Ben Bernanke, the former Chair of the Federal Reserve, once remarked, “Life is incredibly unpredictable; any 22-year-old who believes they know exactly where they’ll be in 10 or 30 years is lacking imagination.”
As time goes on, not only does life change, but so do various factors such as income levels, savings rates, spending habits, inflation rates, interest rates, stock market returns, and countless other variables that are beyond our control.
That’s precisely why financial planning should be viewed as an ongoing process rather than a one-time event. It’s crucial to adjust your plan along the way as new information and circumstances come to light.
Personally, I find the concept of working backward from your spending needs to determine how much you should save quite appealing.
Daniel Kahneman once posed a thought-provoking question: “How can we understand memory? By studying forgetting.”
And as Charlie Munger often emphasizes, “Invert, always invert.”
Attempting to calculate the exact amount you’ll need in savings or income is pointless if you don’t have a clear understanding of your cost of living.
The Bureau of Labor Statistics publishes average annual spending levels by different age ranges:
Each person’s situation is unique, but examining spending trends across different age groups reveals a general trend. Spending tends to climb in the 20s and 30s, peak in the 40s and 50s, and then progressively fall.
This pattern is consistent with common sense and can be used as a guideline. Your income may not be sufficient to support extravagant spending in your early years. However, when you hit your forties and fifties, you frequently face extra financial responsibilities while reaching the pinnacle of your earning ability. Finally, as you get older, you may become less active, resulting in less expenditure.
Retirement planning raises numerous challenging questions that require careful consideration:
- Do I have sufficient savings to support my retirement lifestyle?
- How much should I allocate for healthcare expenses during retirement?
- When is the ideal time to start receiving Social Security benefits?
- What if a market crash occurs right after I retire?
- What will be my tax rate during retirement?
- What returns can I realistically expect from my investments in the future?
- How can I ensure that my savings will last throughout retirement?
The realm of retirement planning often lacks clear-cut answers, and the notorious phrase “it depends” frequently comes into play.
To tackle these questions, you need to delve even deeper and ask yourself additional inquiries:
- What amount of debt do I currently carry?
- How much does my lifestyle tend to inflate over time?
- What is my current savings rate, and how will it evolve in the future?
- What assumptions am I making regarding market returns?
- Will I have dependents who rely on me financially?
- How expensive is the cost of living in my specific location?
- What percentage of my portfolio do I plan on withdrawing each year?
- How will my spending habits change as I grow older?
- How adaptable am I willing to be with my expenses based on market performance?
- What other sources of income will I have during retirement (such as pensions, Social Security, or part-time work)?
- What are my financial aspirations and goals?
- How long can I anticipate living?
Aligning your investments with your goals is critical. It is difficult to decide where to invest if you do not understand why you are investing in the first place.
While we can rely on the past, the future should be approached with a variety of possible outcomes in mind. It is critical to adjust your assumptions and financial strategy as reality unfolds and expectations shift.
The truth is that your financial objectives will change over time. Your target amount will vary as you age, deplete your portfolio, and see predicted returns materialize as historical returns.
Because the future rarely emerges as expected, financial planning needs a regular revision of both statistics and expectations. It is critical to constantly reposition the goalposts as new information and insights become available.
What is your retirement number?
Applying the 25x rule
The computation is straightforward: simply multiply the annual income you anticipate needing in retirement by 25.
What is the magic retirement number?
According to the Schroders 2023 U.S. Retirement Survey, working Americans aged 45 and older anticipate to need around $1.1 million in retirement savings, but only 21% expect to have even $1 million. This is a little decrease from the 24% who said they anticipated to save that much in 2022.
What is the average retirement number?
According to the most recent Federal Reserve data, the average American has $65,000 in retirement savings. The average salary at retirement age is predicted to be $255,200.
What is the best number to retire with?
The amount you should save each year for retirement is determined by a variety of criteria, including your planned retirement lifestyle, estimated retirement age, life expectancy, and present savings. However, financial experts generally advise saving at least 15% of your annual gross income for retirement.
What is your retirement account?
An individual retirement account (IRA) is a tax-advantaged strategy to save for retirement. An IRA is a financial institution-set up account that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis.
On the most recent Ask the Compound, we discussed this topic.
RWM advisor Ross Cohen joined me this week to go over other questions about saving vs. spending, yields on short-term bonds vs. money market funds, the different investment accounts you can open for your kids and retirement accounts for people who are self-employed.
Additional Resources
10 Steps to Retire as a Millionaire
What Is Retirement Planning? Steps, Stages, and More