How Much You Should Save for Retirement, Based on 139 Years of Data
lifehacker.com
lifehacker.com
1) The lifehacker article doesn't list the 2 most important sanity check #s. What is the rate of return that they're assuming for the equity and fixed income?
2) If you dig into the actual research, with the hard to find link, it's actually not really 60% equity, 40% bonds. It's 60% large cap equity (which performs worse than all equity and low cap) and 40% short term bonds (which over long time periods underperform long term bonds, though are less volatile).
3) Despite digging into the linked article, I still can't find assumed rates of returns.
4) Why are we to believe the next 40 years will be like the last 139? The last 139 had a different set of wars, different stages of development, a different tax regime, and different government.
All this talk about "Starting early" assumes a few things:
1) That you can afford to. How many retirees who today contribute 10k/year could have afforded that in 1973?
2) There are no massive events that wipe out returns. We've had two in the past 13 years.
This doesn't mean don't save, but it does mean don't overestimate the value of saving early. (It's not worth eating out of tin cans to squeeze an extra $500 into a pension)
Edited to clarify my comment on bonds and starting early, and fix a formatting issue on the second list.
The point is that you invest in something which has greater growth and dividends, as well as something secure.
Right now I'm very young, so I just put a certain amount away into Canadian bank stocks and other stocks with a history of ever-improving dividends.
I think there's one particular guy somewhere here in Canada which retired at 30-something on a fairly plain job by investing in solid stocks for the long term.
What can we do?
1 - Invest reasonable amounts in aggressive enough well diversified tax friendly financial assets with low fees. (Low fee index funds in 401Ks, and 529s for folks with kids)
1.5 - Delink your financial investments from your human capital. If your salary (& options) are very tied to the success of silicon valley, don't invest in the NASDAQ. If you are working for a mining company, avoid commodities funds because you don't want your investments to lose value the same time you lose your job.
2 - Avoid high cost debt. (Credit cards, unsecured bank loans, etc)
3 - Invest time (and if needed, money too) in your professional education continuously. Assume your skills (and salary) will degrade on a trendline of 5-10% each year that you don't invest.
4 - Plan on working a long time. (75? Note - this isn't as hard as previous generations, because less of the work is manual)
5 - Invest in your health, since you'll be working and living longer.
6 - Invest your time in a happy and healthy home life.
This sets you up for a pleasant surprise of retiring at 55 if the situation allows, or 75 if it doesn't.
You may want to assume no rate of return above the rate of inflation over the long term in your retirement calculation.
Why? Because, if you assume you have a rate of return, you must assume you are taking risk in order to get returns above the risk-free rate.
Rather than assuming you will earn interest in the market, people may want to consider the strategy of saving like they won't earn interest and scaling back as they get older.
The OP suggests that the past 139 years may not look like the future 139 years. I'd say they almost definitely won't.
The current generation entering retirement has very big problems ahead, and the younger 20-35 year old generation will have even larger problems with retirement.
If you follow my strategy, retirement planning is easy:
1) Assume no inflation in either investments, salary, future needs (this makes sense since they match)
2) Figure out how much money you want to live on in retirement using today's dollars.
3) Divide the number by an assumed interest rate. I'm using 5% for my retirement. (that number is higher than you would get today in income and lower than what has occurred over a long period of time.)
In order to have $100,000 a year salary in retirement, you would need to have $2M in the bank in today's dollars.
+++This isn't a perfect calculation, but seems far more realistic than assuming you will earn a return above inflation. (An alternative would be to assume you earn a leveraged return above inflation. Its more risky, but could be argued.)
Pension calculators which assume e.g. a 7% annual rate of return (with apparently no inflationary concern) are just financial propaganda.
>4) Why are we to believe the next 40 years will be like the last 139? The last 139 had a different set of wars, different stages of development, a different tax regime, and different government.
Yes, past performance isn't a good thing to go on, but speculating on the future regulatory environment and business environment and the rabbit hole of poorly understood interactions is even less useful.
Look at the SPY index, which is total returns (including dividends) of the S&P. Take it back to 1994, which is as far as Yahoo Finance allows.
http://finance.yahoo.com/echarts?s=SPY+Interactive#symbol=sp...
In the almost 20 years since, there are many 5 year periods of rapid drops, and many flat 10 year periods.
If you look as the NASDAQ it gets much worse.
One can say, "It's been a rare 20 years" but who are we to say the business environment pre-1994 is more similar today than post-1994?
I think you can't speculate on what the future will look like, you have to prepare yourself for the uncertainty. (Invest in yourself and your health, prepare for the possibility of retiring later, don't ignore your spouse so much that they divorce you, etc.)
This is not true. What if you are buying during an inverted yield curve? Do you think buying long bonds, today, with rising rates on the horizon, would do better than rolling short bonds?
The real mistake in the article is assuming there's some "safe" allocation ratio(60/40 or 40/60!). There are periods (like now with bonds, or stocks in summer 2000) where buying certain assets are a recipe for disaster. But we do anyway. People are going to have to become far more financially literate about their financial futures.
>There are no massive events that wipe out returns. We've had two in the past 13 years.
There is no need to "assume" those things away when planning long term. For example, equities have recovered their value plus more since the 2008 plunge. The people who lose are the people who sell into the panic (or those who happened to be retiring right at that moment, bad luck). But volatility happens. If you held on, you're back on track.
Over most time horizons, when the yield curve isn't inverted, the longer bonds due perform better, but not necessarily enough to justify the volatility.
In terms of equities - I agree, you should hold them. In general equity investments should be "Buy and hold for a long long time". That said, if you look at the past 20 years, there were many 5-10 year periods where you would be down or flat. If you are assuming a fixed retirement date, there are a lot of bad years to retire.
http://finance.yahoo.com/echarts?s=SPY+Interactive#symbol=sp...
I believe that it's much safer to assume we may have to keep working while we keep saving and waiting for asset values to return.
Me neither. I'm trying to put my money where my mouth is and learn as much as possible. Otherwise, I'll be a broke "retiree" like everyone else!
>"Bill Gross wrote about it recently"
Gross is an interesting dude, and you can't take away from his success. But his fund could be in trouble if we see a "too fast" rise in rates. He likes to talk his book.
>"we may have to keep working"
This, on many levels.
To keep this in the spirit of HN, I think there are going to be some interesting opportunities in the financial education/boomer retirement help space.
The underlying assumption in retirement planning is that your investment mix is supposed to change as you get closer to retirement. If you invest 60/40 at age 30 and you're still in that same 60/40 mix at age 60 you're taking a huge risk. The closer to retirement you get the more you shift out of risky equities and into safer, lower-returning investments.
Risk at age 20-something is not the same as risk at age 60-something.
Which is the same nonsense that people have been spewing for years, in articles just like this. It's wrong.
"Bonds" aren't inherently less risky than equity. This will become apparent when interest rates rise, and people who piled into bonds at historically low yields get hammered.
Like the article says, and is being discussed throughout this thread, if you want to make enough money to retire following rules like this, you're going to have to sock away far more than is realistic for 90% of Americans. The only answer is to learn as much finance as you can, which also isn't realistic for 90% of Americans. It's a tough situation.
A LifeHacker post is a LifeHacker post is a LifeHacker post. For the details you want, Wade's blog is here: http://wpfau.blogspot.com/
Jon
The advantage of putting money into a pension (rather than regular savings) is presumably that you get to save the money in a relatively tax-efficient way.
In the UK, you can presently take a percentage as a tax-free lump sum, and an annuity allows you take advantage of an assumed lower tax liability at retirement. That's all very nice. However, if you have 40 (or even 50?) years until retirement, you'll be relying on several governments not to pull those rules and pinch from your pension pot, and you're relying on the financial industry to kindly look after your money for that long.
More urgently, putting money into a pension means that you don't have it for what you need now: if you need to pay off (or simply avoid) expensive debt, or if you need to save for housing rather than paying extortionate rent/mortgage costs, those should likely be higher priority.
There are not many young people who can put those concerns to one side and start saving earnestly for retirement.
The notion - not to save anything - actually comes as a bit of a surprise to me, so I thought I'd point it out.
Pensions are certainly not a magic bullet that is perfect for everyone, they are however something that should be seriously considered by most people. You don't have to make the decision between saving for a house or having a pension, if you can afford to save for a house then it's very likely you can afford to contribute towards a pension too!
[1] During the 80s and 90s a lot of people looked upon pensions with suspicion and opted out, now personal finance forums are full of people regretting this and blaming the media for the hysteria that has left them penniless. Most people didn't opt out of contributing to a pension to instead invest in stocks or property, they opted out to spend an extra £100 a month on luxuries.
[2] For every £60 I put into my pension the government matches it with £40 (roughly).
Most young people genuinely can't afford to save for a pension beyond the state-provided pension - if you have any significant pension at retirement, you're in a position of luxury.
People with private pensions are, objectively, significantly wealthy retirees who don't really need or deserve such tax protection as they presently have. This has already begun to change: the age-related allowance for pensioners has been scrapped, this year.
You might be right that the political incentive won't be there (certainly, the media has spun the 'granny tax' impressively), and surely you won't suffer from being able to afford both housing and retirement savings, but the generation gap between wealthy old people and struggling young people is definitely causing increasing political tensions.
re your [1] : Compared to spending £100 a month on luxuries, almost any sort of saving is better. £100 a month on lottery tickets is probably better (from an investment point of view). If you haven't got the financial discipline to save £100 a month then set up a direct debit to take it soon after payday or whatever. Any high street bank will be happy to do this.
re your [2] : Can you please provide info on this? I can't easily find info on it. I found the following:
"You pay Income Tax on your earnings before any pension contribution, but the pension provider claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot" [1]
First in any investment strategy it is far better to pay off any debt first. Borrowing money while saving is absurd because the interest you incur on your debt is always higher than the interest you receive on savings. And borrowing while playing the stock market is even worse. Given the recent new of most people's debt, I suspect reducing debt should be _most_ _peoples_ concern. This includes things like checking if your mortgage agreement allows you to pay off more than the minimum to finish the mortgage early.
After that, you can invest up to £11,520 a year in a tax free ISA (albeit only £5,760 in cash for unknown reasons). Unlike pension income, withdrawals from ISAs are not taxed, there is no age limit, you can withdraw as much as you like, and its always your legal property. That last point is a big plus.
My dad paid into a company pension for 30 years. Then they went bust, and it turned out the directors had raided the pension pot. Some diretors got suspended jail sentences but that doesn't mean they had money to give Dad though. So he only qualifies for the State pension all the time wishing he never went in with all the 'your money is protected' assurances.
Also yes absolutely, trying to beat the cost of debt with savings isn't going to work for most people, perhaps I should have clarified my position a bit better: I think that if pensions and retirement were taught in school it would be a part of proper financial education, financial education would teach people how to properly manage money and so most people would be considering setting up a pension before they had any debt and if they did enter into debt it would be smart debt (mortgages, business loans and the like) not bad debt (to pay for a holiday or new gadget).
Although ISAs are good for saving (over not saving) the returns are negligible compared to a pension, with a pension the tax relief and potential employer contributions would greatly exceed any potential returns from an ISA. If we round up and say the limit on an ISA is £12,000 per year and the interest rate you could get on £12,000 was 3% and you're a 20% tax payer then you'd need to earn £15,000 to get £12,000 cash (after 20% income tax), then if that £12,000 sat in a 3% ISA for a year you'd earn £360 (tax free interest) making your total £££: £12,360.
If you earned £15,000 and paid it into a pension that £15,000 would never be income so it would never be subject to any tax, so already you're £3000 ahead. The tax relief on £15,000 for a 20% tax payer would be £3,000 meaning the contribution to your pension (assuming 0 employer contributions) is £18,000, 50% more than if you took the cash and put it into an ISA, after only a year! Pensions aren't ever taxed, it's only the income that is taxed once you take it at retirement, if your pension payments remained below the income tax limit (at present that's just over £10,000 for a retiree) you'd never pay a penny. ISAs and pensions are completely different in terms of what/why/when to use them but a pension is absolutely the more financially sound long term investment.
What happened to your father sucks a lot and it's definitely the case that some people did get the short end of the stick in years gone by (and it's shameful that it was allowed to happen) but fortunately pensions are now much more regulated and it's very unlikely for this sort of thing to happen again. If someone is confident that they can make better use of their money to secure their long term financial future by not paying into a pension then so be it, but for most people (in my experience at least) it's not "pension or ISA?", "pension or property investment?" it's "pension or an extra night out every week".
Pensions security information can be found here: http://www.pensionsadvisoryservice.org.uk/security-of-pensio...
Assuming you have covered your debts and housing costs and have decided to forego luxuries and still have enough spare cash to save in a pension, then:
This situation can benefit you, yes, but only under the assumption that you will have a lower percentage income tax liability in retirement compared to your liability now.
This is typically true under the current system for present-day retirees, but is not guaranteed to continue. If you do end up paying the same percentage income tax after retirement, having a pension agreement or not will make little difference to your wealth. With a pension, we are now taking a risk that depends on the future of the political system. I understand if you think that's a fair enough risk, but there's more:
A pension is legally locked up until age 55, a pressure point that may prevent you from accessing accounts with properly competitive fees in the future (since you won't have access to accounts outside the pension system, you may also have to suffer the worst of the financial industry).
If there's any reason you need the saved money prior to 55 - you can't access it and will have to make expensive decisions to cover this. This is the final nail in the coffin for me: unless you have a whole bunch of rainy day savings, on top of your house ideally with no debts attached, a pension becomes a poor risk compared to non-pension savings IMHO.
In the example where you quote numbers, you seem to have double-counted the tax relief for a basic rate payer (your numbers are wrong; though they seem correct for a 40% payer - high earners may benefit more from a pension).
Best of luck with your investment decisions.
People typically wait too late to save or pay off debt. It's very easy to hang yourself with debt in this country. It's probably the worst thing about living here. You can make good money and feel broke all the time because you signed up for two car payments, a student loan, and a 30 year mortgage where the payment almost entirely goes to interest for the first decade.
The gist is that 20-something year olds come to the Bay area (or wherever else), go from graduating college to suddenly having high-paying jobs, and then they blow their money on short-term edification without thinking long-term. And so I think this type of personal planning for a future is important, too. Maybe down the road, we've accumulated a nest egg, or have enough money in the bank to bootstrap!
(Does the EBX article generalize? Yes, very much so, but my hunch is that the article raises insightful points that are definitely worth more than the generalizing or ranting that detractors might point out, for the record.)
In the past 140 years, the United states has gone from backwater to superpower, has enjoyed stable & good governance, has not been invaded, has been able to plunder a large amount of "greenfield" resources, et cetera.
The next 140 years cannot be as (relatively) fruitful for the United States. When you're number 1, relative growth is hard/impossible, and you must rely only on absolute growth.
The trivial answer to the question in the title is "you cannot save enough to account for everything". If you're saving in dollars, you can be wiped out by hyperinflation. If your investments are on the NYSE, what happens if it gets nationalized after a revolution?
Of course, the answer is that you pick a level of risk that you're comfortable with. Anybody that tells you anything is 100% safe is misleading you.
And remember that rare events are much less rare than most models predict (cf Taleb).
I mean, we know that if you put a bundle in the market in 1980, you did pretty well. you did the same in 2000, not so much.
No average can make that easier.
edit: put differently, none of us live long enough to benefit from 140 year averages
That is a very shaky assumption if you are in your 40s now, and outright laughable if you are significantly younger.
Forms of rejuvenation of function in specific tissues have been demonstrated in the lab in recent years, and the SENS Research Foundation continues to gather support and funding. Other research groups have their own SENS-alternatives in terms of plans to treat aging by addressing what they believe to be the primary causes. Biotechnology in general is showing no signs of slowing down.
Are there any proven life extension techniques beyond calorie restriction and regular exercise? I see a lot of possibilities and early research projects, but essentially nothing in the way of results.
If you're healthy enough that working to maintain whatever income you need or want (you might work less, because you need less, or go without working if you can; this is about having the option) remains a reasonable prospect till 75, and drop dead at 76, then retirement isn't a huge issue.
We don't, strictly speaking, need people to live to be 150 to solve the retirement problem. (In fact, them living that long in poor health would be counterproductive; however, it's almost a certainty that radical life extension requires rejuvenation.) We just need for people to be healthy and able to work while they are alive.
Obviously this chart is totally useless other than to simply say save what you can. Last I calculated it, I would have to work a little more than another 100 years to retire. So, I'll be starting that new saas when I'm about 120.
For the first time in awhile here, we're doing worse than our parents. Dang baby boomers.
It says that if during retirement you want to replace 50% of your income average during your working years, you need to save approximately 17% of your working income over a 30 year period.
Isn't it time to look for a better job?
Around this part of the US there are jobs, but ever since the economic downturn the pay never rebounded, and now that employers realize they can get us developers cheaper, I don't expect them ever to go up that much any time soon.
Given also that I can work from home, and am the sole support of my family, I don't want to take the risk of getting in an even worse position.
This is why I spend many, many hours trying/doing side work to pay the bills. Here's to hoping my upcoming saas will actually gain traction...
While the article makes a good point about retirement, the numbers are likely to be incredibly different from the reality we will face.
Retirement is for middle-class fuck-ups. If you don't have a major, live-anywhere-you-want-and-never-have-to-work-again hit by 40, then what the fuck did you do with your life? If you're halfway smart, you'll be financially independent (startup exits, at least two, plus passive income) by your mid-30s. What the fuck are you doing? Go out and raise a $800,000 seed round!
I don't actually think that way, but a lot of people do, and when you compete for jobs (usually on wage) you are in the market with them. They depress wages (if they aren't thinking about retirement, why should you?) but they also push up demands in a lot of those bullshit cultural competitions (such as the need to live in Manhattan in many NYC firms) that get very expensive and kill what you should be saving.
That is why, barring unforeseen technological or economic changes, most people in the VC-funded bubble world will never be able to save enough for retirement. To save requires being smart, and you're typically going to be competing (on wages and rent) with people who are stupid.