Unless you’re the doctor from the moron doctor and dentist story from last week, you probably plan on retiring at some point in the future. Some of you might be interested in doing it at 30, while others are interested in doing it by 70.
I’m thinking as life expectancies continue to go up, most of the people reading this will be working into their 70s. Not necessarily because they have to, but because the average life expectancy will approach 100. Even if you can afford to retire at 60, that’s 40 years of doing nothing but hiking up your pants to your nipples and eating dinner at 4:30.
Although the danger isn’t really there to the general public, I think there’s a real danger among the personal finance geeks among us to over save. We’re obsessed with running out of cash when we’re 90, so instead of saving a decent amount, we want to save enough so just about every variable is dealt with. Having a 98% chance of never running out of money isn’t enough, we want a 100% chance.
So we save and save and then save some more, because that’s what we do. Oh, you maxed out your TFSA? Great, now how about that RRSP? No? Slacker. For most Canadians, maxing out both of those accounts represents about 25% of their gross income. That’s a lot of savings.
If you’re like me and life is sort of a competition on who can accumulate the most, this post probably isn’t for you. We like saving and investing. Not so much for the fringe benefits, but because we like poring over balance sheets and income statements. We’re weird like that. You, not me.
Most people aren’t like us. All they want is to be able to check their investments once a year, notice they’ve (mostly) gone up, and call it a day. These people have an investing problem, and they’re more than happy to pay outrageous mutual fund fees to solve it.
And yet, we tell them “INVEST EVERYTHING YOU CAN OR ELSE YOU MIGHT RUN OUT OF MONEY ALSO I HAVE TO POOP.” We don’t offer a solution to the problem besides telling people to put aside everything they can or else.
What if we saved a little smarter? What if, instead of focusing on a percentage today, we focus on trying to come up with a set amount 40 years from now and then work backwards from there?
Let’s say you want $1.5 million in today’s dollars for your retirement, and you’re 31 years old. You’re currently wearing a black t-shirt and jeans, and you had a caesar salad with chicken in it for lunch, details which are not important yet were included for some reason. You currently have $50,000 set aside for the years of shuffleboard and jigsaw puzzles, which is set to begin at 65.
First off, we have to figure out the effects of inflation. Based on 2% inflation going forward, I’d have to save 1.96x what I plan to now. So I’m looking at $3 million, give or take.
It’s also prudent to be conservative in figuring out returns, so we’re going to assume 8% going forward, or 6% after inflation.
Punch those numbers into the compound interest dealie, and here’s what we get.
We’re looking having to save an additional $13,000 per year for retirement in that scenario, which isn’t terrible if you’re a family with two decent incomes. It’s certainly achievable for the PF geeks in the house.
If you’re like most people, saving $13,000 per year is pretty aggressive. What if we used the projections to scale back our retirement projections? Instead of shooting for $3 million, we shoot for $2 million? After all, that’s the equivalent of about $1 million today, which gives a couple $40,000 per year based on a 4% withdrawal rate at today’s dollars. That’s plenty, assuming a relatively conservative lifestyle and a paid off house.
Here’s the results:
That’s much more achievable for a family trying to make it in today’s world of high real estate prices, expensive childcare, and era where both spouses need next-to-new cars for some reason.
From there, you can play with the numbers to further tailor to your individual situation. Many people plan to save more when the kids have moved or the house is paid, as an example. I’d caution against delaying saving too long, since compounding is more powerful when you’re young. But still, it’s an option. So is downsizing when you’re older, or moving to a locale with a cheaper cost of living.
The bottom line? There are more intelligent ways to save for retirement than just throwing every spare dollar into retirement accounts. Don’t over save today just to be sitting on a pile of cash come retirement age. By working backwards and making adjustments along the way, you might end up needing less than you think, leaving more cash available today for buying things like presents for Nelson. Everybody likes that, right?