When I read that 49% of Americans are not contributing to any retirement plan at all, I was not surprised to find out that the biggest offender group were people between the ages of 18 to 34. My guess is that it’s not that they don’t want to do it, but rather that they don’t know how to save for retirement.
The last time there was a round of 401k sign-up at work, my younger colleagues seemed hopelessly lost. They were given a nice big folder of papers containing numbers of charts, and told the old “you should probably contribute 10% of your paycheck” advice.
But when it came down to, they really just had had no idea how to save for retirement. When I’d ask them if they felt 10% would be enough, I was met with blank stares like a deer in the headlights.
The Bigger Picture:
When you’re told something trivial like “you need to save 10% of your paycheck”, it just doesn’t tell you enough about how to save for retirement. What does a 10% savings really mean for your future? Will that get you to retire at age 65? 55? 40? Even when you do retire, does that mean you’ll be rich enough to be sipping Margaritas on the beach, or eating dog food for dinner?
Without knowing ANYTHING about stocks, people still meet their retirement goals all the time by properly figuring out how to save for retirement and setting their saving rates accordingly. All it takes is a few basic assumptions to get started. The hard part is having the discipline to keep it going!
Figuring Out How to Save for Retirement Made Easy:
So as not to overwhelm my younger colleagues, I tried to boil down volumes of retirement advice into the simplest and easiest list of steps I could think of for how to save for retirement. So here is what you need to do to get started:
Step 1 – How Much Do You Make Right Now?
Your standard of living is dependent on how much you and your spouse make right now. Take the combined total of your household gross income (before taxes).
Example: Before taxes: You $50,000 + Your Spouse $50,000 = $100,000 Total.
Step 2 – Multiply Your Income by 80% to Figure Out Your Retirement Income.
Due to a variety of reasons, many experts theorize that you will only need approximately 80% of your gross income by the time you retire.
Example $100,000 x 80% = $80,000 in retirement income.
Step 3 – Divide Your Retirement Income by 0.04 to Figure Out Your Nest Egg Size.
When you hear people talk how to save for retirement by building a “nest egg”, they’re usually talking about creating a pile of money so big that you could take 4% out each year and virtually never run out (in theory because the nest egg keeps replenishing itself).
Example $80,000 / 0.04 = A $2,000,000 Nest Egg.
Step 4 – How Many Years Until You Want to Retire?
If you don’t know, simply pick a number! It’s okay because you can always revise your savings goals. Keep in mind that most retirement accounts won’t let you withdraw until age 59-1/2. Once you decide on that age, simply subtract that number from your current age to figure out the number of years.
Example: Let’s assume you want to retire 30 years from now.
Step 5 – Are You an Aggressive or Conservative Investor?
To keep things VERY simple, how do you feel about risk? Are you comfortable investing in stocks that may have big wins and extreme losses, or do you prefer bonds which have smaller gains but lower losses? If you fancy yourself as aggressive, then we’ll use an 8% average return rate. If you’re more conservative, then we’ll use a 6% average return rate.
Example: I’ll say that I’m more aggressive and use an 8% return rate.
Step 6 – Calculate How Much Money You’ll Need to Invest Each Month.
This will be the amount that you and your spouse need to save each year or month to hit your target (Note that it can be split this savings goal between you and your spouse as you see fit). The calculation can be done very simply using Microsoft Excel. When figuring out how to save for retirement, it usually involves a finance calculation that takes into account compound returns, and this is usually too difficult to figure out on paper.
Example: Using Excel, I find that I need to be saving at least $16,347 per year or $1,333 per month.
What Does All This Tell Me?
The important thing to take away from the exercise is an overall big picture about what your needs will be and how to save for retirement to get accommodate them. If you take the time to figure this out, you’ll know how much money you’ll need to save each month to generate a lifetime of income that will help you enjoy the same quality of life that you do now.
I encourage you to try this exercise several times with a variety of different variables. See how the numbers change and how one small thing can affect your bottom line.
Making It More Complicated – Beginners, Cover Your Eyes:
For all the Haters out there – Remember that this exercise is intended to be an introductory guide for the Beginners. Don’t overly complicate it just yet with your economic rocket science and “what about inflation” theories. Making the question of how to save for retirement too complicated in the beginning for young people will lead to exactly what’s happening now – nothing!
To the Beginners – As I’ve mentioned, this is just a very basic introduction. You should know that every single step in this how to save for retirement exercise is based on assumptions that are surrounded by a massive amount of debate. Here are a few examples:
• Some people may argue that you need anywhere from 60% to 100% of your current income during retirement. What if you want even more?
• Some people may argue that you should take out 2% instead of 4% during retirement.
• Some people may argue that a 4 to 6% average annual return is about the best you could hope for over the next 30 years.
• Some people will argue that you need to factor taxes and inflation into your calculations. Although they are correct, to do so would require a more advanced lesson.
Does this mean this exercise is useless? Not at all! It simply means that there are just a lot of opinions out there.
If there is one thing you should learn from My Money Design, it’s that there is never one right answer! If you’re concerned about which variables are right and wrong, simply try running the exercise over and over again and get a range of results. At some point, you’ll notice a reoccurring figure that will basically become a “safe” target for you. Although it may not be precise, at least it will be a target to strive for!
Readers: What advice do you give to beginners who are just starting to figure out how to save for retirement? How much will you need to save each month? Are you on target right now or no where close? What is your opinion on these variables? Are there other factors you consider when projecting how much you’ll need to save each month?
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