How Much Do You Need to Retire?

How much do you need to retire? The old rule of thumb was 75% of your preretirement income. Where do these rules come from? Dan Ariely, the James B. Duke Professor of Psychology and Behavioral Economics at Duke University contends, no one knows where such rules of thumb originate. Once created, if financial advisors and the financial press pick them up, they become conventional wisdom. If someone seeking advice has read much of anything she will ask a financial advisor this question as a sort of a test already knowing the answer she expects to hear. The financial advisor, hopefully better informed that her potential client, knows the answer she is expected to give. Ariely concludes this psychological drama adds little value to answering a very serious question.

He decided to approach the question from a psychological point of view. His surveys asked questions like, “Where do you want to live in retirement? In what sort of activities do you want to participate?” The people who told him they would need 75% of their preretirement income to achieve their goals in retirement in fact would need 135% of their preretirement income to achieve their stated retirement goals. Ariely is not surprised by the results of his survey. Most people do not expect to sit in front of their television for 16 hours a day after a lifetime of working at a job that over 80% of them found unfulfilling. They want to live in Margaritaville. They want to go sailing on cruises in the Caribbean with their grandchildren. They want to play golf every day. They want to go on the adventures they could have taken in their twenties but didn’t because they had responsibilities like car payments and children.

The amount of money required to provide a 135% retirement is so enormous that only the most diligent or fortunate could ever imagine achieving such a goal. Yet people pay for financial counsel that won’t achieve their goals (real 75%? or imaginary 135%?). Ariely notes these same financial counselors give their clients risk tolerance questionnaires to help determine the makeup of portfolios designed to achieve their goals (gold coins buried in Mason jars? or Zimbabwean currency futures?) I just filled out one of these questionnaires after opening a new account. By looking at the questions, I knew the results before they were tabulated. I expected that I would come out with a slightly above average risk tolerance. That was the result. The survey stated that people like me hold about 60% in stocks. I have a little less than that but more than the old conventional wisdom would recommend for someone of my age and situation.

Ariely notes, “Money, it turns out, is incredibly hard to reason about in a systematic and rational way (even for highly educated individuals). Risk is even harder.”

“Knowing others is wisdom. Knowing yourself is enlightenment.” Is an old Chinese saying sometimes attributed to Lao Tzu. Start by examining your life. Ask yourself how you are using money today. Ask yourself how that is likely to change once you no longer have a regular full time job. I would like to buy Robin Master’s estate in Honolulu and drive about Oahu in a beautifully restored Ferrari 308 GTB. However, that is unlikely given my projected retirement income. Perhaps I could buy a modest brick ranch style home on a secluded lot somewhere near the shadow of Paris Mountain and drive about Greenville County in 2010 Acura TSX.

Next, construct a plan to achieve that goal. Implement your plan. As the song says, just wishing and hoping and thinking and praying, planning and dreaming alone in the dark will not help you reach your goal. As you study the results, modify your plan to better match reality. Someday that goal will be yours.

Oh, by the way, one recent survey (I don’t have the reference) found that people actually spend about 80% of their preretirement income after they retire. They drive fewer miles, spend less on clothing, and lunch at the company cafeteria. Of course the kids are gone now and most of them have paid off their mortgage. Some of them move to low tax, low cost of living states, leaving them more than enough money for that famous margarita they serve at Dirty Mary’s Tiki Bar located on Florida A1A somewhere south of Miami.