When you are twenty something years old, it's pretty hard to worry or think about retirement planning because it is so far off in the future and there are so much other fun stuff to occupy your time and drain your checking account. But the truth is that the best time to establish a plan and start saving for retirement is when you are just starting your career. Retirement planning and investing, done early, essentially guarantees a comfortable retirement.
By the time you reach forty something which, by the way, comes in a flash, it is critical that you have started a retirement plan and are investing in that plan regularly. The magic of compounding only works when you have time remaining on your side. A reasonably comfortable retirement is still within reach, but you will work harder to achieve that goal than if you had started in your twenties.
If, by the time you reach fifty something, you have not made significant strides in building a retirement fund, you are going to need either a miracle, a bequest from a rich uncle, or you will need to plan for a delayed retirement.
This article provides some statistics on retirement savings, some guidance on how to calculate what you should plan to have saved for retirement, and what steps to take if you are behind the curve on your retirement plan.
Millennial Generation Retirement Planning
The Millennial generation is the youngest group consisting of those born in the years 1982 through 2004 or, as an age group, between the ages of 13 and 35. While the last members of the Millennial generation are just entering middle school and high school, the earlier members of this generation are at the prime age to establish a retirement plan and ensure they will have a comfortable retirement. This is because time is on their side. Another thirty years of compounded returns essentially ensures this group has the potential to not only fully fund their retirement plan but to also have enough money for leisure travel or other fun and games.
This of course is made possible with regular periodic investments and the compounding of returns. As an example, we can simulate how much would be accumulated and what the annual distribution would be for a typical individual retirement account (IRA).
The table above assumes that the owner invests the maximum amount currently allowed by the IRS, $5,500, annually and regularly during the accumulation years. The real return (after inflation) is assumed to be 5%. The annual distribution amounts are based on the owner living for 25 years after retirement and taking the annual distribution each year of retirement. So, for example, a 25 year old starting their retirement savings plan and retiring at the age of 65 could accumulate almost $700,000 in today's dollars and they would be able to withdraw $47,000 per year for 25 years after retirement at 65. For comparison, the average annual total living expenses for a retired couple in 2013 was just shy of $47,000.
If sufficient funds were available, a married couple could effectively double the amounts in the table above. In other words, a couple could accumulate nearly $1.4M and take annual distributions of $94,000 under the same retirement assumptions. Either the spouse could fund their respective IRA or the other spouse could fund the second IRA under current IRS regulations. WOW! Is it really that easy to accumulate a large retirement fund?
Yes, it really is that easy. Readers should also note that these numbers are exclusive of any Social Security payments. For those readers wanting to simulate their own retirement plan accumulation, there are roughly a bajillion retirement calculators available on the internet. I like the version offered by the CalcXML site that is linked here.
Some readers will ask "How do I know that I can achieve that level of return on my retirement investments?" To that I say, "Let history be your guide." For the period 1950 to 2009, if you adjust the S&P 500 for inflation and account for dividends, the average annual return comes out to exactly 7.0%. That is 7% after inflation. Readers should note that I have used a return of 5% after inflation in the example above, well less than 7%.
I mentioned above that in 2013, the average annual expenses for a retired couple were just shy of $47,000. How should one go about estimating what their retirement expenses will be? I'll probably catch some flak over this, but I really don't like the simple multiplier on current income approach. The most widely used approach is to multiply your current income by 80-85% and use that number for your estimated retirement expenses. The problems with this approach are many. Your income will vary over your career, and while you may earn big money for part of your career, there is no guarantee that you will earn at that level over your entire working life. One of the other key issues I have with this approach is that if you are getting by at $40,000 per year, in retirement, $32,000 may not be sufficient. On the other end of the scale, if your are killing it at $400,000 per year during your career, there is no reason to assume you will need $320,000 per year in retirement.
My recommendation is to do a bottoms-up retirement budget. If you have several years of living expenses under your belt during your career, you have a very solid basis for estimating your needs during your retirement years. Being an engineer, this type of methodical approach comes naturally. I pay all the family bills either using a credit card or via electronic payment from my checking account. About the only thing I pay cash for is my haircut every 3 weeks. My barber, Tim, is the only guy in the area I trust to give me a proper high-and-tight cut and he doesn't take credit cards. Since I have all of my monthly expenses running through my checking account, it is a simple task to download that data to EXCEL and keep a 12-month running total of the family's expenses. So, I know exactly how much we spent for the 12 months ending January 31, 2017 (after I adjust for the haircuts). With that data, I can estimate our expenses in the future by including planned expenses (e.g. buying a new car, moving to a retirement locale, college costs, leisure travel, health insurance) and reductions in living costs (e.g. moving to a smaller house, no work commuting costs, fewer lunches, cutting your own grass, etc.). Since everyone's retirement picture is different, and you are best equipped to define what that picture looks like, you are in the best position to estimate your retirement expenses. I encourage this type of approach rather than using a simple multiplier on your current salary.
Unfortunately, with all the wealth building potential that time and compounding offers, the Millennial generation is off to a slow start on retirement savings. As a group, the average saving rate of the Y-generation is... negative.
Source: Moody's Analytics
This is not good. Another often quoted statistic is that 70% of the Millennial generation members have no retirement plan or retirement savings. While doing research for this article I ran across another statistic that roughly 34% of Millennial males spent more on coffee than they invested in a retirement account. While that is pretty bad, 44% of Millennial females did the same. To read more about the spending and investing culture of the Millennial generation, click here.
I think the take away message here is abundantly clear. The Millennial generation has time to their advantage. Don't wait, start your retirement planning today. Delaying your plan or your retirement savings/investments will only serve to make it harder to achieve a comfortable retirement. With at least 25 years until retirement, Millennials have the luxury of investing in a low risk diversified and balanced portfolio of stocks and bonds (after the Fed rate increases) and being almost assured of building a nest egg that will provide a comfortable retirement.
Generation X Retirement Planning
Generation X, those born inclusive of the years 1965 through 1978, are probably the best prepared of the three generations for their retirement years. That is not to say that everyone is well prepared (an absolute statement), but they appear to be in marginally better shape than the Boomers and the Millennial generation. This group is currently in the age bracket between 39 and 52 years; in other words, in their prime earning years. Based on the latest survey by the Transamerica Center, 77% of Generation X members have a retirement plan and are currently accumulating retirement savings. The median age the Generation X group started saving for retirement was 28 and the median contribution is 7% of their current earnings.
Those statistics sound pretty good. But, the median value of Generation X member's retirement accounts is only $69,000 and 30% of the group have taken early withdrawals from or loans against their retirement accounts. That $69,000 median value is not going to provide much additional income in retirement. Luckily for Generation X members, you have some time on your side to continue to add to your nest egg and grow it by investing in the equities.
Today, about the best bank CD rate you will find is in the range of 2-2.3% for a 5-year term. Shorter duration CDs and bank money market accounts are offering interest rates well less than that. In my view, bond mutual funds and ETFs have too much downside risk with the Federal Reserve planning 2-3 rate increases in 2017 and President Trump's plans to stimulate the economy with tax cuts and infrastructure spending. You might be able to find a handful of shorter duration corporate bonds or baby bonds that are relatively safe (investment grade) and paying a bit more than today's long-term CDs, but it will require a lot of due diligence to find them. There is a lot of debate as to whether the market is overpriced or fairly priced and whether it will continue with its "Trump Rally". With 15 or more years before retirement, and the need to generate real returns of at least 5% annually, a diversified investment in equities is about the only option that I see as viable today. I'll discuss equities in a bit more detail later in the article.
Baby Boomers Retirement Planning
The baby boomer generation is, by most definitions, that group of people born during the period beginning in 1946 through the end of 1964. I am one of this group. There are a lot of others in the boomer generation, roughly 76 million. Many of us boomers have already begun retirement, but there are many more to follow, roughly at a rate of 10,000 per day. Unfortunately, a large fraction of the boomer generation is not prepared for retirement. The Insured Retirement Institute (IRI) summed up the boomer generation's woes pretty well in their April 2016 Report.
"Approximately 35 million Boomers lack any retirement savings today, a statistic that appears to only be getting worse. The grim legacy for many Boomers, after long working lives spent caring for families, putting children through college, and perhaps caring for their own parents, will be to struggle financially in retirement as they live long lives, exhaust their limited financial resources, and find that their only income in their later years is a Social Security benefit that may be largely consumed by expenses for health care."
When asked what they would have done differently, 68% of Boomers stated that they would have saved more and 67% stated that they should have started saving earlier. Millennial and Gen X readers should all read that previous sentence again. With 35 million out of 76 million Boomers having zero retirement savings, fully 46%, as a group the Boomer generation is not prepared for retirement. With the youngest Boomers approaching 54 years old, there is not a lot of time remaining to build a retirement fund. For those Boomers born after 1960, the full retirement age is 67 years. Those Boomers have as little as 10 years to get prepared for retirement at 67 if they are not well prepared now. For those same folks, the idea of retiring at an earlier age like 62 is simply a non-starter.
If you are in this situation, you have absolutely no time to waste. Today would be a great time to get started with your retirement plan. Because you only have 10 years to get prepared for retirement, your options for getting prepared are fewer and the choices harder. As I see it, you have the following possible options.
- Work longer and retire later. For each additional year that you work, your Social Security check grows by about 8% and a (hopefully) large share of the income produced by working longer can be invested for retirement.
- Tighten up your budget and bank the savings. Sell that extra car that you don't really need. Eliminate that double mocha grande latte every morning. Brown bag your lunch. Cut back on dining out. Go through your checking account and credit card statements looking for ways to cut expenses.
- Downsize the house. Some people have a large portion of their net worth tied up in their personal residence. Sell it and move into less expensive digs.
- Downsize the country you retire to. There are a number of lower cost retirement destinations south of the border; some are much lower. The idea of retiring to Panama, Belize, Mexico, etc. may seem a bit off-the-wall, but a lot of people have already made the move and the trend is growing.
If you have 10 years or less to your planned retirement age and you haven't made significant progress towards accumulating the necessary nest egg to pay for your retirement, you are in a tough spot and it will require some hard work and hard choices to be capable of attaining your retirement goal.
Investments for Retirement
Up to this point, I've only discussed retirement investments in general terms. In this section, I'll discuss in more detail my thoughts and my approach to retirement investing.
I have never bought in to the concept of rebalancing your retirement investment portfolio more towards bonds as you age. Probably everyone is familiar with the concept of structuring your portfolio such that the percentage of equities you have in your retirement portfolio is equal to 100 minus your age. For example, when you are 20, you should be 80% invested in stocks and 20% in bonds. When you are 80, you should be 20% invested in stocks and 80% in bonds. That approach may have worked when bond yields were in a more normal range, but since I've been investing, I've seen long-term investment grade bond yields as high as 14% and as low as 3%. I'm not sure there is a "normal" any more with respect to bond yields, and with today's yields near rock bottom, now is probably not the time to be heavily invested in bonds.
For this reason, I lean heavily on equity investments for my retirement. This has worked out well over the thirty some years I've been contributing to and growing those investments. While I do have a non-retirement investment portfolio filled with individual stocks and MLPs, all of my retirement funds are invested in mutual funds with the Vanguard group. Specifically, I am invested currently in the Vanguard Capital Opportunity Fund (NYSE: VHCAX), Vanguard Mid-Cap Growth Index Fund (NYSE: VMGMX), Vanguard Dividend Growth Fund (NYSE: VDIGX), and the Vanguard Health Care Fund (NYSE: VGHAX). Currently, VHCAX and VDIGX are closed to new investors, but they should reopen during the next major market correction. In the past, I have also been invested in Vanguard Equity Income Fund (NYSE: VEIRX), Vanguard Global Equity Fund (NYSE: VHGEX), Vanguard Windsor Fund (NYSE: VWNEX), Vanguard Energy Fund (NYSE: VGELX), and the Vanguard Wellington Fund (NYXE: VWENX).
It is important to select a fund with good long-term past performance in both up and in down markets. But, for long-term retirement investments, I believe it is more important to develop a retirement investment plan, stick to that plan, and stay invested for the long term. In other words, it is more important that you develop a plan and execute on making regular periodic investments than it is to have picked the top performing mutual fund, ETF, or CEF. There are a very large number of funds that have performed reasonably well from a number of large fund companies (Vanguard, Fidelity, American Funds, Franklin Templeton, T. Rowe Price, Oppenheimer funds, etc.). Most any of the well diversified decent performing funds from these families would serve you well for retirement investments. Remember, in investing for the long term, it is more important to be invested in the market than it is to beat the market.
Disclosure: I am/we are long VHCAX, VMGMX, VDIGX, VDHGX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.