14 January 2010
Is 10% Enough For Retirement?
For many years, you have likely heard financial advisers instructing you to save at least 10% of your income in a retirement account. I know that I was told that and given the impression that I’d be just fine if I could do this from a young age. I was told that thanks to the miracle of compound interest, that by the time I retire, the money will be growing so fast each year, that I can withdraw a large amount each year in retirement and still make money. In general, I believed them at the time. The more I’ve look at it though, the more I fear that I won’t have the retirement that I expected. I can hear the collective “Duh” coming from my millions dozens of readers across the world. When is the last time that you’ve sat down and taken a look at one of the zillions of retirement calculators online to see how much you’re on pace to save? Did it take into account inflation?
Let’s just take a look at couple of calculations from a home-built Excel file that I created.
The first example is kind of a best-case scenario. Imagine that at the age of 20, you are able to get a job paying $40,000 a year. From the first year, you begin socking away 10% of your income for retirement. After all, you are hoping to retire in the Caribbean at age 65, so you better start young. Assuming that you receive raises that keep pace with inflation (we’ll assume 3%), you will have put away around $370,000 over the 45 years that you’ve saved. With an estimated return of 8% and thanks to the “Miracle of Compound Interest“, the balance of your retirement account has ballooned to over $2,250,000. Yes, that’s over two and a quarter million dollars. You’re a millionaire just like the financial advisers promised. Oh wait, we forgot about a little thing called “The Miracle of Inflation“. Unfortunately that two million dollars will only buy about $950,000 in today’s dollars. OK, so still close to a millionaire, not bad. Well, let’s think about this a little more. With your 3% annual raise compounded, when you retire, you’re making about $146,000 per year. When you stop working, you’ll be ready to start withdrawing from your retirement fund. That two million dollars isn’t going to last very long. In fact, by time you’re 85, you’ll be almost out of money and you’re expenses will be higher than ever.
If that was a best-case scenario, then I’d hate to see a worse case, but let’s look anyway. Suppose I’m 30 and figure I still have 35 years to save. I’ll be fine. Unfortunately at 30, I only make $40,000. Well, when I turn 65, my account balance will stand at $957,719 with a purchasing power of $502,689 in today’s dollars. It still seems like it’d be nice to have almost a million dollars when you retire, but just realize that you would likely be making over $100,000 in salary by that time. Doesn’t sound like so much after all. In this case, your retirement savings may last you 9-10 years, if you’re lucky.
My judgement would lead me to believe that 10% just isn’t going to cut it. Just out of curiosity, I tried 15% and found that with the same scenarios above, my retirement income would last me until around 100 years of age. If I die earlier, my kids might even get a little something. Now for my final trick, I’d like to see what 20% would do. This is currently how much I actually save, thanks to my company’s matching. If I had started with 20% saved since age 20, I would expect to have enough money to survive until I turn something like 150 years old. Apparently there are two keys to saving for retirement.
1) Start Young
2) Save a LOT OF MONEY!
Now, after all that, I actually have come to a completely different conclusion. Instead of relying on the stock market, I’d much rather rely on my own skills to provide for my retirement. Although I will continue to save through my 401(k), I will also be looking into various other ways of providing for my elder-years. I already own real-estate and plan to continue that as well as investigate small businesses and other opportunities.
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2 Comments currently posted.
Chris Sumpter says:
Richard Sumpter says:
All is probably true. However, keep at the foundation of your beliefs “God will provide all that I NEED”. I may not need to eat, I may not need to live. But….whatever I do need…He will see to it that I get it. Having said that…a half million dollars would be a good base for trying to figure out how to live, even in an inflated economy….much better than having nothing to show for all the years of labor. I applaud you for caring enough to do these calculations and for taking an ealier interest in your future. At the ripe age of 58, I wish I had been a bit more frugal in my early days of marriage, so that I would enjoy the last half better. You still have a chance to take that step. My financial advisor cautions me to find a balance….don’t spend your life as a miser, but be responsible too. Figure out what you should do…and do it with all your might.
I’m saving 15% of my somewhat meager salary, and our organization is putting probably another 15% into a retirement fund. If returns don’t significantly improve before my retirement, there may not be much to live on, in which case I’ll hope my little brother’s real estate plan panned out.