Are you saving enough? Most Americans are not saving near enough for a comfortable retirement. A number of large investment managers suggested that investors simply use rules of thumb (i.e. - 8x income) to determine what they will need to save for a comfortable retirement. It is important to note that simple rules of thumb do not work for many people. When planning for retirement, income uncertainty can be substantial, so a one-size-fits-all solution is unlikely to work.
Why do people need to save so much now?
- Very few people have pension plans today.
- Current low interest rates create lower returns and income from bonds and cash (vs. history).
- People are living longer, and have more years to support themselves in retirement.
- Medical costs keep increasing and can become very expensive for retirees.
- Social Security and Medicare may be less generous, means tested, or bankrupt in the future.
What are the keys to a successful savings plan?
- Start saving at a young age. The power of compounding can then work for you for decades. Albert Einstein stated, “Compound interest is the eighth wonder of the world. He, who understands it, earns it ... he who doesn't ... pays it.” Who wants to argue with Einstein?!
- Save a lot. Most people need to spend less, and save much more than they are now.
- Save consistently. Never stop saving. DO NOT stop saving because the stock market drops 20% and it seems too scary to invest at the time. Keep saving and keep investing.
- Automate your savings plan. Have the money taken out of your paycheck automatically so you don’t even see the money, and you won’t miss it. Save first, spend what’s left.
- Use tax advantaged investment vehicles. Utilize a 401(k), IRA, or SEP-IRA and max out your company 401(k) match.
- Increase your rate. Increase your savings rate by 1% per year until you get up to the 15% per year (or more) target. You will barely notice the difference each year.
- Invest in a diversified portfolio. While accumulating savings, invest in a diversified portfolio of mostly stocks and stay there.
Retirement rules of thumb?
We don’t intend to completely beat up on those that use rules of thumb. Rules of thumb are helpful to many people because they simplify the process and give them a way to easily understand things and get started. If you insist on using rules of thumb, consider these two retirement rules of thumb: 1) you are likely to need about 85% of your pre-retirement income to live on in retirement, and 2) the 4% rule—you can spend about 4% of your portfolio each year in retirement and be confident you will not run out of money over the course of a normal 25-30 year retirement. We think these are pretty good rules of thumb. Rules of thumb are generalizations and can be helpful, but it is much better to have a customized, long-term financial plan based on your own personal situation and assumptions. Every family is different.
It is somewhat dangerous to use a simple multiple of income as your guide. There is no one-size-fits-all number. Retirement costs vary considerably from one part of the country to another. If you are going to use a multiple of something to target the size of your retirement portfolio, it should be a multiple of your annual spending not your annual income. Take your current net worth (excluding your primary residence) and divide by your annual spending. That is a relevant number! The closer that number is to 20+ by the time you retire the better. If that number is over 25, you are in good shape.
Many in the financial industry treat financial planning as a one-size-fits-all outline, with little concern for the specifics of your life. We believe that a true financial plan is the process of navigating the challenges of your life journey.
To be effective, a financial plan should grow and change along with you. Pinnacle Trust's approach is built on the philosophy that your wealth should enable your life, not control it. We take the time to help our clients see beyond immediate financial concerns to achieve a greater vision of fulfillment and security for themselves and their families.
Our financial planning process begins with an understanding of your vision of financial wellness. What does success mean to you? What does your ideal life look like?
By starting from your individual vision, we are better able to put common challenges into proper context. For example, your vision of retirement might be a second career, a new business, or continuing your career well into your senior years. We avoid rigid plans and prepare for any necessary adjustments when your life journey changes.
Martin Palomo serves as a Financial Advisor and Investment Officer for Pinnacle Trust. You can reach Martin by emailing him at firstname.lastname@example.org or by calling him at 601-707-3047.