Tuesday, January 26, 2016

More Than Ever, It's Up to You

The graphic contains Fidelity’s latest version of their rule of thumb for retirement. Let’s try to see how this might work out for a hypothetical retired couple. The husband worked full time for 40 years with a final salary of $60,000 a year. The wife left the work force for fifteen years to raise a family. However, she retired with a full time final salary of $40,000 a year.

Let’s assume they have no pensions, but expect $36,000 a year in Social Security. Another rule of thumb states they will want 80,000 a year in retirement in order to maintain their lifestyle. If they have managed to save $1,000,000 in tax favored retirement accounts as Fidelity suggests, our old friend the 4% rule states that they can reasonably expect to draw $40,000 a year from their portfolio. They are $4,000 a year short. That is pretty close. They are going to be OK even without downsizing to a smaller house in a cheaper warmer state.

From my viewpoint, the problems with this chart are the first two hurdles. Gen X and the Millennials have been conditioned by our consumer society not only to accept debt as a norm, but to welcome debt into their life as a rite of passage into adulthood. Most of our young adults carry credit card debt and a car note. Far too many young people have believed a lie. There is no guarantee that $30,000 or more in student loans will magically create a job opening that will allow them to repay this debt in a few years. In fact, from what I have read and witnessed, it appears that student loans are robbing their victims of at least ten years of their adult lives.

Even if a hypothetical young couple receives a good basic education in personal financial behavior, it is hard to simultaneously save for retirement and for the new normal, almost mandatory 20% down payment on a new home. Even on a $150,000 house which would be hard to find in most urban areas, $30,000 cash money for a down payment is hard to come by when baby needs a new pair of shoes.

The earlier you can save more money the better. The magic of compound interest, favors long periods of time.

$1,000 that receives a 6% rate of return over 40 years results in $10,828.46
$1,000 that receives a 6% rate of return over 20 years results in $3,290.66

Those calculations are assuming that the interest compounds 4 times per year.

The good news is the stretch drive. If you pay off the mortgage early; if you get the kids out of the house on schedule, you can accomplish miracles in the last 10 to 15 years of your working life. These are typically the years when you will be earning maximum income. No mortgage payment adds a $1,000 a month or more in after tax income that can be invested in a Roth IRA that will produce growth and income—tax free—forever! I never quite reached the widely recommended target of 15% pretax income into the 401 (k), but I did hit 14%. Something close to a third of my after tax income went straight into savings during those critical final years of my working life. Ten years of that kind of focus can catapult you into a comfortable retirement.

The Baby Boom bought a bait and switch. We were promised a conventional defined benefit pension in our declining years if we gave the best years of our life to our employer. This didn’t happen. By the mid 1990s the handwriting was on the wall. The covenant between worker and company had been broken, but during those boom years, instead of saving for retirement we were taking out second mortgages to finance luxury vacations and new SUVs. Too many of my generation aren’t going to finish the stretch drive until they are in their seventies. This logjam will limit employment opportunities for the generations that are following us. Not everyone who is planning to work until he is 70 is going to be healthy enough to finish the race. Those that do will have lost those early retirement years when we would be better able to enjoy a little travel and extra time with the grandchildren.

More than ever, it is up to you. Don’t count on the Government or your employer to lead you into the Promised Land. Instead take responsibility for your own life. Bite the bullet. Make those hard decisions. Stay out of debt. Consistently live on less than your income. Invest that surplus in an age appropriate mix of stocks and bonds or even income producing real estate, if that is your thing. It is quite reasonable for a young couple just starting out on the road of life to expect that they will retire with at least $1,000,000 in investments. Add another $300,000 or so in home equity and Social Security.

Life can be good. Don’t let anybody tell you that you can’t do it.

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