Listening to Myself

Wednesday, January 19, 2005

Retirement Savings

I recently read an interesting article in the Contra Costa Times about saving for retirement. The basic premise of the article is that people need to be saving a lot of money, and that saving more and starting earlier is far more important than getting a high return on your investment. For example, they state, based on their research:

Say you're a 30-something, with 30 years to go before retiring. Assume that you've already saved a year's worth of your current pretax salary. (In other words, if you make $100,000 a year, you've banked that amount.) Say you plan to invest conservatively during your working years, with 40 percent of your holdings in stocks and 60 percent in bonds. Then assume that you will downshift even more during retirement, to 20 percent stocks and 80 percent bonds.

According to the simulation, there is a very good probability -- 80 percent, to be exact -- that you would be able to replace 41 percent of your preretirement income once you left the work force. That assumes that you're able to save and invest 15 percent of your salary annually during your working years. (This figure includes all sources of savings, including your 401(k) money, 401(k) matches from your employer and profit sharing.)

Now say you decided to become more aggressive, putting 60 percent of your money in stocks and 40 percent in bonds during your career and then moving to 40 percent stocks, 60 percent bonds in retirement. Although you are now taking on considerably more risk, T. Rowe Price's study says this strategy is highly likely to let you replace 43 percent of your income in retirement -- a difference of just 2 percentage points.

On the other hand, if you increased your annual savings rate modestly, to 20 percent from 15 percent, you'd be able to replace 52 percent of your income -- and that's under the original, conservative asset allocation strategy that emphasized bonds.

Pretty interesting, I thought... but the kicker is this. Their savings recommendations for wage earners are pretty amazing -- and I don't think they are anything near what people are actually socking away.

The Schwab research center did its own study of how much investors should be saving, based on traditional assumptions like an 8 percent annual rate of return and 2.5 percent annual inflation. Its conclusion was that 20-somethings should be saving 10 percent to 15 percent of their salary each year, while 30-somethings who have nothing in the bank should start saving 15 to 25 percent annually. And those in their early 40s who previously neglected to save would need to set aside 25 to 35 percent a year.

If you are able to save this much, you should be able to replace most of your current income in retirement. However, do people really need their full income in retirement? I think that people are going to end up wanting something close to it, at least for the first decade or so. After that, they'll probably be a little less interested in travelling and doing some of the more costly activities we commonly associate with retirement. Unfortunately, they may also have an increase in medical costs at this point, so perhaps the lifestyle savings are negated.

Related to this, I recently read one of John Mauldin's Outside the Box newsletters, titled Saving for a Rainy Quarter Century and written by Gary North. It talks about the situation boomers are going to find themselves in, and offers very good, seldom seen suggestions on what people should think about doing while they still have the opportunity. I think it also offers a cautionary tale for us younger folks, and gives us a hint of what we may be going through with our parents in the future.


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