Kudos to John Waggoner for his article “Retirement savings for the median worker” which appeared in USA Today on November 8, 2013. Waggoner’s article explores a person living on the median annual income trying to save for retirement at age 65. The median family income in 2012 was $51,071. Back in 1975 it was $11,800. Assuming a worker saved 5% of his income from age 22 until his retirement at age 65, his savings should have grown to $1,000,000. John assumes this person invested in a 60% stock/40% bond allocation and uses the return for this investment blend from Ibbotson Associates. Using the 4% prudent withdraw rule and adding Social Security benefits (average payout is $1,269/month), the retiree would be able to replace his income at age 65.
Hypotheticals have a lot of problems and should not be interpreted as a guarantee of future results. However, this story is refreshing when most headlines are telling us today’s worker won’t be able to retire at age 65. The bottom line – you need to save regularly and start early. Here are some lessons we should be passing on to our children and grandchildren. Time is on their side if they start saving as soon as they have earned income.
How much should we save – Waggoner’s hypothetical uses a constant saving of 5% through the workers career. Your savings goal should be 10%. A young person may not be able to save 10% when they are starting a family and buying their first house. They should begin with something and make it a goal to increase it each year until they retire. According to Dr. Thomas Stanley, author of The Millionaire Next Door, the average millionaire saves 20% of their income and they’ve done so long before they were a millionaire. They live on a budget which is how they were able to control their spending to the point they could save 20%.
Invest regularly – Waggoner’s worker was not trying to time the market. It’s tempting to sit on the sidelines when the stock market is falling. But you’re not going to reach your retirement goals holding cash in a money market. You may miss some of the downside in the market but no one can time the market accurately. You’ll likely miss out on more of the upside. The best time to buy is when the market is down, not when you feel comfortable, and trying to time your entry and exit into the market almost never works.
Maintain the correct allocation – Is 60/40 the right allocation? Not necessarily. I advise young people to put 100% in a broadly diversified stock portfolio to get started. Dollar cost averaging is going to make up for asset allocation until the portfolio grows. Once the balance is over $100,000 then I switch them to 80% stock/20% bonds. Asset allocation takes some of the volatility out of the portfolio which decreases the temptation to sell out in down markets. Buying high and selling low assures we will never reach our retirement goals.
Live below your means – Is it possible for a family to live on the median income of $51,071 and still save 5%? The truth is you can never out earn your desire to spend no matter how much you make. That’s why you need to control your spending first. Children should be forced to save so they can develop the habit before they become adults. This should be an obvious and simple rule to follow but it isn’t. If you take home $1,000 per week, you cannot spend more than $1,000 per week. Yet, people spend or commit to spend more than they make in the hope that a bonus, overtime pay or a tax refund will eventually help them to get caught up. I often hear people say, “If I just made more money, all my financial problems would be solved.” The problem is not that they don’t make enough money. The problem is that they spend too much. The way to control spending is by creating a budget and living within it. Without a budget, you will always be blindsided by expenses for which you are unprepared.
Have a written financial plan – Retiring at any age is much more achievable when you create a plan to reach this goal. You’ll need a short-term financial plan that we call a budget. The long term portion of the plan establishes the level of savings, a plan to get out of debt and an investment plan to reach the target date for retirement. The plan becomes your road map. There will be detours along the way – your goals and the plan will need to be adjusted as you progress in life. Keep working at it. Don’t be distracted by outside influences you can’t control.
- The minimum savings goal should be 10% of income.
- Allocating investments between stocks and bonds helps to reduce the portfolio volatility.
- A written financial plan helps to keep you focused on your long term goals.