Monday, May 14, 2007

Saving For Retirement

When setting retirement goals, we often have alot of formulas and benchmarks thrown our way. Subtract your age from 100, and that's the percentage of your holdings you should have in stocks. You'll need to generate annual cash equal to 60-70% of your pre-retirement income. You will need 1.6 times your salary in savings at age 35, 3.5 times your salary at age 40 (and so on... check out the article at The Simple Dollar). Head spinning yet?

Perhaps the most simplistic formula to follow is "Save 10% of your gross income." (I have also seen 15% discussed as the number to save.) This keeps it simple - you're not having to sit down and draw up a pro-forma budget for 30 years in the future. It's not alot of complex math. It doesn't even take into account your asset allocation. Just save 10% of your gross income.

Will this work for you? In a word, maybe. If you begin religiously saving 10% of your income at the very beginning of your career, and invest wisely, there is the distinct possibility you'll have a comfortable retirement. Real life doesn't always work that way. To wit:

  • Did you start saving 10% right away, in your early to mid 20's? (I didn't.)
  • Will you stick with it consistently for FORTY YEARS STRAIGHT?
  • What will happen when emergencies occur? Busted furnace, car accident, you have a special needs child, roof is leaking, etc etc. Will this throw off your ability to save 10%?
  • Could you possibly have any clue how much money you're going to need to live your daily life 30-40 years from now? Can we even predict how much health insurance and college tuition will cost? How much will our government tax us in the future?
People want a simple answer to know that they are saving enough to retire. While I will not pretend to know what life is going to cost me in 30-40 years, I will preach the following:
  • Start now! No matter what your age, begin saving immediately. If you are in your 20's, start saving yesterday! I wish I could appear as an apparition before myself back in the 90's - I would haunt the 20-year-old version of myself and spookily say "SAAAAAVVVE." Save anything you can - any amount, no matter how small. It adds up!
  • Invest aggressively. I have invested in an apartment building, index funds, and small cap stocks (these stocks being the very aggressive part of my portfolio). Bonds are not for me - history shows their return is inferior to stocks, and as I'm only 36, I cannot afford to be conservative at this time.
  • Track your progress. Create a spreadsheet outlining your net worth, and update it at the end of each month, just like businesses that run month-end statements. Print it out and review it. Talk about it with your significant other. Shame yourself into never looking at a month-end statement that's lower than the previous month.
  • Set annual goals, and don't fall short. My goal is a 20% increase in net worth every year. This is very easy to achieve initially, as increasing your net worth from $5,000 to $10,000 yields a 100% increase! As you accumulate wealth, your percentage increases will drop. However, I have committed to myself that the percentage increase will never be below 20%. I haven't missed an annual goal yet.
Realize this - if you do not start saving early, the annual amount you must save goes up. The money you're saving in your 20's will seem like a pittance. It is not - save everything you can, because it adds up. If you do not start saving early, that 10% number goes up big time! If you're 50 years old, making $80,000 a year, but you haven't saved anything, that 10% savings figure is now 30% - probably impossible to achieve.

Start saving now.


Alex said...

I completely agree with you about bonds. They make a lot of sense if you are going to draw from the money in the next 10 years, but I am 26, I can't draw from my 401K for 34 years, and bonds have almost never beat stocks in any 10 year period. Why should I lower my rate of return just to diversify for diversity's sake?

Q said...


You will receive advice saying you need to diversify - and that therefore you need some bonds. I say no to this. Diversification for me is making sure no one position I hold comprises more than 5% of my portfolio. And, it means owning some boring index funds along with picking stocks.

Adventures In Money Making said...

check out Ben Stein's rules of retirement:

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