Retirement savings: How much is enough?

Over the last few months, I’ve read several articles that center around the idea that people should be saving every possible dime that they can for retirement. For example, Daily Finance recently had an article entitled Forget the 4% Rule: Retirement’s Common Wisdom Is Obsolete:

The theory was simple: If you spent a maximum of 4% per year of your retirement funds, the decline in principle will be slow enough that your money would last as long as you did. Though the percentage seems modest and the reasoning sound, this 4% rule ignores two factors that have become increasingly, glaringly relevant: first, market volatility, which has battered retirement savings over the last decade, and second, inflation, the silent force that erodes purchasing power year after year.

What does that mean?

The other issue with basing your retirement plan on simple rules is that it can lead to complacency. But the idea that you can “set it and forget it” and everything will be fine is a trap.

“There are so many ‘experts’ telling people different things, that they’re not going to have to worry,” D’Arruda said. “A rule means something in writing, something enforceable. But in retirement planning, there’s a fluctuating source. You can’t take a guarantee.”

Let’s look at an example case from a reader that I’ll call Marvin.

Marvin has $800,000 put away for retirement, mostly in really conservative stuff like bonds and cash. Overall, he’s earning about 2% a year on his money. He was bitten by the stock market collapse in 2008 and doesn’t want his money in stocks. Marvin wants to retire in ten years, so he wanted to know how much money he should be putting away.

I asked him a few questions. How much does he anticipate spending (in current dollars) per year in retirement? He told me about $50,000. What will his Social Security benefits look like? He estimated around $1,500 a month (adding up to about $18,000 a year).

I told him that if he wants to retire in ten years, he should be putting away every single dime he can starting right now and that he should anticipate trying to earn at least some income during his retirement.

I don’t think Marvin liked that answer.

Why did I tell him that, though? The big reason is that his plans for retirement are riddled with uncertainty.

First of all, there’s inflation. Let’s say inflation grows at 3% a year for the next thirty years. If he’s estimating spending $50,000 in today’s money, during his first year in retirement, he’s going to be spending just shy of $70,000. During his eleventh year? $93,000. That’s more than 10% of his total retirement balance. His Social Security might go up a little, but it’s not going to go up that much.

There’s also the issue of fluctuation in investment returns. Right now, Marvin is very conservative and only earning a 2% return on his money. That’s not enough of a return to build substantial wealth. With that level of return, unless he contributes more, he’s not going to even crack $1 million for his retirement plans.

If he moves into stocks, he will likely get a higher long-term average annual return, but it will be highly volatile. He might average out to 5%, but one year might see a 20% loss while two other years might see 15% gains. Volatility at the wrong moment in retirement can eliminate years of living expenses and you won’t have time to see the market rebound save you.

There’s also the issue of uncertain lifespans. If Marvin retires at 65 and lives until 75, he’ll be fine. If Marvin retires at 65 and lives until 95, he’s going to be in big trouble. None of us know for certain how long we’ll live.

The article seems to imply that individuals shouldn’t be involved in planning for this and that financial advisors know better. I don’t really agree with that. All of these factors rely on knowing unknowable facts about the future. No financial advisor in the world can tell you how long you’ll live, how volatile the stock market or other investments will be in the next ten years, or what inflation will do in the future.

However, there’s one thing that almost no one can argue with. The more money you save for retirement, the more money you’ll have when it comes time to retire. The more you put in now, the more you get out later.

The solution is simple. You can either save as much as possible for retirement now so you don’t really have to worry about this too much. On the other hand, you can save less and accept that your final years will likely involve leaner living.

I am almost always of the belief that if I can make a minor sacrifice now, that’s far better than having to make a major sacrifice later. If I can squeeze out another $1,000 a year right now, that might add up to another $1,500 a year in retirement.

It might make the difference between never going out to eat with my wife or having a nice dinner out with her once a month.

What do I have to sacrifice today to get there? If it’s something small that I can give up and apply that savings to additional retirement savings, then it’s well worth it.

That’s how I look at retirement savings. I’m making little sacrifices now so that I can enjoy life more later on. If I can resist that new gadget that I don’t really need and probably won’t use very much today, I can have some breathing room and a little less stress and a little more fun later on.

It is never a bad move to save more for retirement.