Savings Matter More Than Investment Returns For My Retirement Portfolio

by: Big Alpha Research
Summary

Personal savings rate for December 2018 was 7.6%.

The estimated savings rate required to cover household expenditure is between 9.2% and 10.3%.

The savings rate has been higher than 9% only in 4 years during the period from 1960 to 2018.

In John Mauldin's article (The Average American Can't Save Enough To Retire), the message is clear, and it is dire: An average American tapping on social security, receives $1,420 monthly. This is based on social security's fact sheet, available here.

In my previous article, I reported that the 2016 median net worth of an American Household was only $50,000 at ages 45 to 54 if we exclude the value of the property they live in. While this figure is dated, I will continue to use that $50,000 figure to articulate my point on the importance of saving.

I will illustrate how critical it is for us to start saving and setting aside money for our retirement. However, just looking at this $50,000 figure, any reader would know one cannot survive on a return on investment on a $50,000 portfolio. Assuming a 45 year old has an aggressive investment portfolio and a desire to retire at 65:

Current Age 45
Years before retirement 20
Investment portfolio $50,000
Annual Yield 10%
Future Value of Portfolio $336,375
4% dividend (monthly) $1,121
Social security payout $1,420
Total monthly benefit $2,541

This 45 year old, without setting aside any amount of his/her income as savings, would payout $2,541 monthly before applicable taxes. After taking into consideration an inflation impact of just 1%, the present value of that 4% yield on the $336,375 portfolio is only $919 a month! Adjusted back to present value terms, the total monthly retirement benefit from social security and a 4% yield on the retirement portfolio would only be $2,339.

In contrast, the average expenditure of the household above 65 has increased from $26,533 in 2000 to $49,542 in 2017.

Historical household income and expenditure

Year Chained CPI Consumer All Items (Dec YoY) Age 55-64 Avg. Expenditure % change Lifestyle Impact Over 65 Avg. Expenditure % change Lifestyle Impact
2000 2.60% $39,340 -0.10% -2.70% $26,533 0.00% -2.60%
2001 1.27% $41,462 5.39% 4.13% $27,714 4.45% 3.18%
2002 2.02% $44,330 6.92% 4.90% $28,105 1.41% -0.61%
2003 1.70% $44,191 -0.31% -2.01% $29,376 4.52% 2.82%
2004 3.15% $47,299 7.03% 3.88% $31,104 5.88% 2.73%
2005 2.88% $49,592 4.85% 1.97% $32,866 5.66% 2.79%
2006 2.27% $50,789 2.41% 0.14% $35,058 6.67% 4.40%
2007 3.67% $53,786 5.90% 2.23% $36,530 4.20% 0.53%
2008 0.22% $54,783 1.85% 1.64% $36,844 0.86% 0.64%
2009 2.46% $52,463 -4.23% -6.69% $37,562 1.95% -0.51%
2010 1.28% $50,900 -2.98% -4.26% $36,802 -2.02% -3.31%
2011 2.93% $53,616 5.34% 2.40% $39,173 6.44% 3.51%
2012 1.48% $55,636 3.77% 2.28% $40,410 3.16% 1.67%
2013 1.32% $55,892 0.46% -0.86% $41,403 2.46% 1.14%
2014 0.52% $56,267 0.67% 0.15% $43,635 5.39% 4.87%
2015 0.43% $58,781 4.47% 4.04% $44,664 2.36% 1.93%
2016 1.81% $61,346 4.36% 2.56% $45,756 2.44% 0.64%
2017 1.69% $64,972 5.91% 4.22% $49,542 8.27% 6.58%

Source: One-Screen Data Search

The expenditure shortfall will only lead to a predictable outcome, which is to continue working. While this may still be a possibility today, a lot of jobs in the future might simply be displaced by technology or structural shifts in the evolution of certain industries. I am uncertain that I would, for example, be a taxi driver in the event I needed to because the world in future would be serviced by autonomous driving vehicles.

We therefore desperately need to save. However, this rate of savings has been declining from a 2012 peak of 12% down to just 7.6% in 2018! While consumer spending boosts the economy and (hopefully) creates jobs and (maybe) wealth of the average American, it is unwise to save just 7.6% of income!

Source: statista.com

It is also insightful to observe by contrasting the table above against the total personal savings value historically.

Value of Personal Savings in USA $1.06 Trillion in 2018 Source: Statista.com

While the savings rate grew from 6.2% to 7.6% between 2017 and 2018, total value of savings grew 275% from $384 billion to $1.06 trillion. I infer that the rich (smart) guys are actually stashing away more money.

The 7.6% savings rate and does not adequately cater to the retirement aspirations of the average salaried worker. Based on the 45 year old household 2017 median income of $80,671 obtained from the US Census Bureau (link here), the annual savings would equate to $6,131.

Assuming the same investment yield of 10%, the future value of investing $50,000 and $6,000 every year until 65 would be:

Current age 45
Years to retirement 20
Current portfolio value $50,000
Annual savings $6,000
Return on investment 10%
Future value at age 65 $680,025
4% yield $27,201
Monthly distribution at retirement $2,267
Inflation rate 1%
Equivalent in present day terms $1,858
Average social security payment $1,420
Total monthly payout $3,278

The average expenditure of 65 and above households is $49,542 or $4,129. There is a 20% shortfall before achieving this goal. I have also assumed a phenomenally low inflation rate of just 1% over the next 20 years. A tweak in this assumption to 3% would make the total monthly payout $2,675, a 35% shortfall to the required target to make ends meet.

Applying this range of 20% to 35% shortfall into the 7.6% savings rate would result in savings having to be at least 9.2% to 10.26%. This has to be done consistently each year in order to just get by upon retiring.

The fact that the savings rate has only been higher than 9% just 4 years during the period between 1960 and 2018 demonstrates just how difficult this task is for the average American.

It is time, therefore, to thoroughly consider one's spending habits.

Note: I did not factor in other taxes and 401k plans into this assessment, or one-off large ticket costs like healthcare.

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.