Begin your retirement journey with an end in mind.
Before your next bag of chips, remember that $1 is worth potentially $45 at your retirement.
American savings rate need to be drastically improved in order to retire and it starts with every dollar saved.
Americans are not saving enough. At a peak post-2008 crisis, the savings rate peaked at 11% in 2012 and has steadily declined from there on.
The impact of not saving enough is that we would have to deplete or borrow or rely on the state, our friends and family to tide through our old age. The alternative would be to continue working even as we age. That prospect, however, is looking bleak; as technology extends life, it also displaces traditional jobs, and many will be structurally unemployed, especially if we have not invested in learning new skills or in adopting technology. My dad, now in his 70s, barely manages to use his smartphone, for example.
Hence there should be a growing emphasis on building up a strong financial profit and loss statement and a balance sheet with healthy reserves. Much like how investors approach stock picking. We peruse financial data, we review the company's strategy and future competitive landscape and we make a decision whether the company's current value is lower than what it should be, or would be in future.
Plan your retirement
The average retirement age for an American is 66 years, according to a Gallup Survey in 2018. Assuming a college graduate starts out work at 25 years old, this graduate would have about 40 years to accumulate funds required for retirement.
How long does it take to retire if we save on average 11% of our disposable income? Assuming you spend as much during your retirement as you currently do, 11% savings rate yielding 5% returns would take 49 years before you are able to withdraw a 4% distribution annually upon retirement to cover expenses.
For those who have worked for a longer period of time, we may think we are in a better position than the 25 year old graduate. We could be married, have a stable job, a car and a house. Well done for those who are able to achieve these successes in life!
However the median household savings as at June 2018 is between $34,0000 and $77,000 for middle-income households in America. Even the upper middle class households have about $157,0000 which probably would last them 5 to 7 years to retire on?
I earlier mentioned that savings rate peaked at 11%. The typical American saves about 3% of disposable income in 2018, meaning that many would have to work well beyond our retirement!
A conscious decision to save
The best way to begin the retirement journey is to review our personal financial position and it begins with our balance sheet and profit and loss statement.
The investing community on Seeking Alpha might be interested in getting the yields and returns on their portfolio. I am equally fixated on searching for superior returns than market. However, trying to beat the market and earning above 10% might be more difficult as compared to saving 10% or 15% from our take home pay.
In investing, we typically look at annual reports and financial statements, management guidance and review business operations before forming a view. Likewise, our personal financial statement and balance sheet needs to be reviewed monthly, quarterly and yearly. We have been accustomed to seeking higher revenue growth, but have we been equally diligent in checking our margin compression (often known as lifestyle inflation) and cost cutting initiatives? The excess savings can then be channeled into potentially higher yielding capex, investments or R&D (such as learning a new skill or getting a degree).
From a personal profit and loss perspective, trimming our expenses and being entirely focused on getting the best value out of each dollar should help any individual. Having this mindset is also very beneficial not only for the middle income earnings but for those struggling to make ends meet and are heavily in debt as well. As members of a family, a community or even as individuals, we are accountable to stakeholders and shareholders as well. Your spouse, children, parents and your future self require you to be accountable for your current actions.
Lifestyle inflation and the true value of $1
In this modern age, we have been blessed to enjoy and experience luxuries that are made accessible through technology. We can now connect with friends across countries through an internet connection, meet friends online for games, watch movies in our house without going out to rent a DVD. All these however have come at a cost. We purchase too much unnecessarily. As an example, I bought the first generation iPhone and never bought another Apple (NASDAQ:AAPL) phone again simply because it was too easy to get hooked into paying for cloud storage. Lifestyle inflation is so prevalent today and the ease of obtaining credit has spurred consumption to a point we hardly challenge our decisions to subscribe for Amazon Prime (NASDAQ:AMZN), Spotify (NYSE:SPOT) or Netflix (NASDAQ:NFLX). Personally, my wife and I decided to cancel our cable TV subscription and basically we have not switched our TV on for the past 3 months! While I do enjoy challenging the norms of a typical comfortable and modern lifestyle, I am not expecting anyone to do the same. Simply having the concept that a dollar foregone could be worth a lot more at retirement would be extremely useful before an expense is charged to the credit card.
Beginning with an end in mind helps transform each purchase decision beginning from the simplest decision whether or not to buy a cup of coffee on the go for $2 at Starbucks (NASDAQ:SBUX). With some idea of what foregoing a cup of coffee would mean ($90 value upon retirement), this helps every consumer place things in perspective.
Value of $1 saved and reinvested at 10%:
|$1 Saved||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00|
Value of $1 saved and reinvested at 5%:
|$1 Saved||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00||$ 1.00|
Turn your savings into income
The average return on the S&P 500 for the past 90 years is 9.8%. Hence it is not unfathomable to save a dollar and reinvest it for $45 in the next 40 years. In my article on my personal retirement planning journey, there are 2 portfolios planned out for retirement. This Financial Independence Retire Early (FIRE) Portfolio has two objectives depending on the stage you are in your FIRE lifestyle and your risk profile. The first portfolio, which is the one I am building currently, is coined as FIRE Building Portfolio and is constructed to reinvest my savings while I work and build my FIRE asset base.
This portfolio has to maximize total investment yield and to grow as quick as possible. In terms of risk, one has to decide if the investment portfolio should be conservative, moderate or high-risk. At the same time, the savings rate from your annual income would be deployed into the FIRE Building Portfolio.
The second portfolio would be focused on maximizing distributions but at as low a risk as possible, and have portfolio asset value keep in pace with inflation, which is important and to be discussed later. I shall call this the FIRE Lifestyle Portfolio.
In the lifestyle portfolio, assuming an average lifespan of 79, the $2 Starbucks will have a potential to generate a yearly dividend of $3.60 if the distribution yield is 4%. That buys you 13 cups of coffee, one for each year until your death.
Hence the total potential value of not drinking 1 cup of coffee a day, which is a big sacrifice to many of us, is $90 and 13 extra cups of coffee in our retirement. There are other ways to get the caffeine fix and often cheap alternatives are available like brewing from home or in the office pantry. A frugal lifestyle encourages creativity rather than deprivation.
From 40 years to 10 years
Once the momentum starts and we review every line item and the personal net assets start building, the habit of saving could actually turn into a hobby or passion! Besides the feeling of edging closer to becoming financially free to pursue what I enjoy, the habit of saving is also a constant creative process to seek how I can pay less for the same benefit of consuming a product or service.
Our household savings rate has a big impact on retirement. In Mr Money Moustache's blog post (here), someone who saves 64% of his or her income will be able to retire in 11 years on an investment return on savings at 5% per annum. The actual calculator is simple and can easily be done here (Early Retirement Calculator).
When savings are combined with investments, the multiplier effect kicks in dramatically. This is where investing well comes in. However, it is our savings (net assets) that allows us to generate a return!
From $1 saved to saving 64% of our income is a gradual process and one that guarantees to be highly satisfying. It is time to consider retirement planning and the sooner the better. Beginning with the end goal in mind helps shape each consumption decision and places short term gratification into perspective. It starts by thinking about the future value of $1.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.