Some people ask when they are young: they have a keen sense of time that I lacked when I was their age, and they have many years to prepare.
Others approach me when they are mid-career, as their kids leave elementary school and they feel as if life is going by far too fast. If the next twenty years go as fast, they think, how will it be possible to save enough for retirement?
And, sadly, every so often I get this question from someone who is late in their career, only a few years from retirement. They have a real sense of fear and unease when they think to themselves: have I saved enough?
Adventure and Security
As humans, we have two fundamental forces that drive our approach to money: adventure and security. The adventure seekers tend to enjoy life’s experiences and leave saving for a later time. The security-minded folks are likely to start saving at a young age.
What it all comes down to, though, is this: how much is enough?
There is no single right answer that works for everyone. But there are four numbers to know for retirement planning. Four numbers that will give you your answer. It doesn’t matter the order in which you find them, as long as you know all four.
1. How long do I have?
You need to know your end point. Of course, if we knew our “use-by” date, it would be easier to plan. But since we don’t know for sure – we have to pick a useful number. So, how do we choose? Well, what I usually recommend – because I’m in the business of managing risk – is using a worst-case scenario number. Not worst-case from a living perspective, but worst-case for how much money you need to save. This number is generally age 90, so this gives you a target (albeit an arbitrary one, in the absence of better information).
2. How old am I today?
Knowing where you’re starting is just as important as knowing where you will end. The earlier you start, the easier it will be to save an adequate amount.
3. What is my savings rate?
How much can you save on a regular (usually monthly) basis? Think of this as the speed you’re traveling, if you were in a car. Your current age is your starting point, and the point at which you stop saving – let’s call it the end point – for the long-term is your age of retirement.
If you are young, you have a long time until retirement – you can travel slowly, with plenty of detours and time for stops. If you continue to save consistently for the long-term, you’re likely to arrive comfortably at your endpoint. But if you are older, you don’t have as much time – and if you haven’t saved enough up to this point, you may have to speed and even risk crashing.
4. What is my rate of return?
This is how much your savings are growing for you, beyond the dollar-to-dollar amounts you are depositing each month. There are several ways to ensure a healthy growth-rate for your savings. Firstly (and most simply), you can lend your savings to others by leaving your money on deposit at your bank or by purchasing bonds. Alternately, you can invest your savings in other businesses via the stock market. Different types of savings and investments earn different types of returns; it is also important to know that some returns are guaranteed, while others are not.
Think of your returns as traveling with a tailwind. If that tailwind is strong, you’re likely earning significant, positive, and consistent rates of return. That helps your savings grow, perhaps even faster than you planned. If, however, your tailwind is weak and the return rate is low – as is the case with the returns you currently receive in a savings account – you’ll have to do most of the driving (that is, contribute most of your savings) by yourself. You may even experience a headwind in the form of a market correction and have to be patient until a tailwind returns.
- where you want to go
- where you are today
- how fast you are traveling, and
- the strength of your tailwind.
Once you have these four numbers, you can plan ahead and make predictions about how much you’ll need to save to create an income for your retirement.