There are 5 pieces of information that are absolutely required to answer the question, "Am I saving enough?" You need to know 1. How much you have saved; 2. When will you start withdrawing; 3. How much you will spend in your 1st year of retirement; 4. How much you will receive from Social Security and Pensions; and 5. For how long will you require a retirement income. And, this 5th item being a total unknown, you will need to plan for a VERY long time.
Then, of course, you will also need to project a couple more things that are completely and totally unknowable, but for which history gives us a decent guide (though never a guarantee). You will need to estimate an average rate of inflation (the amount by which your cost of living will increase every single year while buying the exact same items). And you will need to estimate an average long-term return. More on these in just a moment.
Once you have all these numbers, it is easy to determine if you are saving enough. Here are the steps:
1. Figure out your retirement income GAP. This is the amount you will need, over and above your social security and any pension income you may have, to meet both your fixed and your variable lifestyle expenses. Simply consider your current expenses as your NEED, subtract your expected social security and Pension income and viola – you know your GAP.
2. From this GAP, you can estimate the size of the pool of assets you need in retirement to create this income. The available “rules of thumb” for a lifetime sustainable withdrawal rate vary between 4% and 5%. In other words, take your GAP number and divide it; first by .04 then by .05, to determine the required size of your asset pool before you retire. If you need $25,000 over and above your social security and pension incomes, this means you will need $500,000 - $625,000 before you can retire with confidence.
3. Determine how many years you have to save before your date of retirement.
4. Using a financial calculator, solve for required savings. The financial calculator will require that you input a PLUG number for “performance. For planning purposes, I recommend 5% if you are conservative and 8% if you feel you can handle an above average amount of volatility (risk). NOTE: using the lower number will force a higher savings rate to fill the gap, while using the larger “return” number will allow a lower savings rate (and therefore more current spending). If you go for the high number, you will have to work harder to bolster you belief in the plan as you will be tested more often and with a greater severity by the volatility of the market.
This material is for informational purposes only. Individual circumstances will vary. The hypothetical rates used do NOT reflect the deduction of fees and charges inherent to investing.
Why do we need such a high return? Why can’t I just invest in CDs and trust that will get me there? Simple, with long-term inflation averaging 3.5%, that is the minimum we absolutely require of our portfolios OVER AND ABOVE OUR ACTUAL WITHDRAWALS – just so we can keep pace with our rising cost of future living expenses.
Historically, 3.5% will work over the long term, but we actually recommend using 4% as a plug number. Better to be conservative in your plan and force yourself to save more than to “bet” on low inflation and run out of money.
And, you will need to estimate an average long-term return. This, admittedly, is a total crapshoot in the short-term. No one has any idea what economic calamity is hiding just around the next corner… but I am fairly certain there is one. This being said, it is nothing new and THAT is the primary point. All the short-term shenanigans that people play to anticipate market falls or to “load up” before a big pop are just speculation. We have 3 basic tools that when practiced with patience, discipline and a belief in our collective long-term future will create success.
They are Diversification, Asset Allocation, and Rebalancing…
The only thing we know is that a broadly allocated portfolio participates less than the best performing markets while also participating better than the worst performing markets. It is a voluntary agreement with heaven to NEVER MAKING A KILLING for the priceless blessing of NEVER GETTING KILLED. And, it absolutely works over time, though there cannot be any guarantee.
Any process or plan that entails trying to figure out what will be the NEXT best thing, is a speculation and speculators don’t succeed… at least not for very long. We do not recommend speculation; rather we suggest that we focus on time tested long-term thinking. Stay broadly allocated, stay diversified, consider valuation, and rebalance at least annually.
If you follow the above 4 steps to figure out how much you need to save, follow through and actually save that amount AND you stay resilient through the tough times (which will inevitably come when we don’t expect them, last longer than we would like and be accompanied by catastrophic media headlines suggesting the END OF THE WORLD)… you will get there.
Though, and this is the rub, there are not and can never be any sort of guarantee.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.
There is NO guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment.