Retirement Saving: What Comes Natural is Worst Approach

Most people delay saving for retirement until their income goes up and retirement age is on the horizon. It makes sense. But it doesn't work. Here's why.

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A disturbing pattern surfaces when you quiz baby boomers about their savings habits. The remarkably common experience they relate is that they saved nothing in their 20s and very little in their 30s; they started saving regularly in their 40s but didn’t get serious until their 50s.

This progression is understandable. It generally tracks with rising income and urgency as people age. It’s also exactly opposite the most efficient way to build retirement security.

Morningstar analyst Christine Benz recently polled the firm’s individual investor clients and found that few stuck to any rules of thumb, like saving 10% of pre-tax income each paycheck. Most regretted that they had not started saving earlier. Commenting on a lengthy online thread that her poll generated, she observed:

“The savings pattern laid out by Keith999, who expects to embark on a financially secure retirement soon, will ring true for many investors. ‘In my 20s I spent, in my 30s I spent more, then in my 40s began saving about 6% of salary, early 50s about 12%, and the last 10 years I/we saved 20% of two salaries. The last 10 years probably represent over 50% of the total saved and indeed has put us over the top of what we need.’”

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Keith999 may have secured his retirement this way. If so, he did it the hard way by turning his back on what Einstein purportedly called the most powerful force in nature: compound interest. Consider two savers. One starts at age 20 and saves $2,000 a year for 10 years and then stops saving altogether. With 7% annual growth she’d have $315,676 by age 65.

The other saves nothing until age 40, and then socks away twice as much each year—$4,000—for more than twice as long, in this case the next 25 years. Even with this aggressive catch-up plan she would fall short of the first saver’s total, socking away just $270,705 by age 65. Now imagine the first saver did not stop saving, but kept plowing in $2,000 a year throughout her working life. She’d have $611,503 by age 65. If she upped the contribution to $4,000 at age 40 she’d have almost $750,000 at retirement.

Saving early is the almost painless trick to building retirement security. Young people should open a Roth IRA as soon as they have wage income. If parents have the means, the best gift they can give a working teen or young adult child is a contribution to their Roth in an amount equal to the child’s earned income up to the $5,000 annual limit. I call this a family 401(k).

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We have a retirement savings crisis in the U.S. that is prompting millions of people to plan to work longer in order to make ends meet when they finally call it quits. The Employee Benefit Research Institute’s 2012 Retirement Confidence Survey found that 37% of workers expect to work past age 65, and most of those past 70. That compares to just 11% who expected to work past age 65 in 1991.

Working longer alleviates the problem for many, but generally not for those most at risk. In his blog for EBRI, Nevin Adams writes:

“Last year we modified the Retirement Security Projection Model to determine whether just ‘working a few more years after age 65’ would indeed be a feasible financial solution for those determined to be at risk.  Unfortunately, for those counting on that as a retirement savings solution, the answer is not always yes. Indeed, results from the EBRI modeling indicated that the lowest pre-retirement income quartile would need to defer retirement to age 84 before 90% of the households would have even a break-even chance of success.”

For most people, saving early is the only true silver bullet. Too bad we don’t seem to realize that until it’s too late. In the Morningstar poll, older clients said they were now trying to pass that wisdom along. Writes Benz:

“Many posters noted that they wish they had the importance of saving drilled into them earlier, so they are doing their best to inculcate their children in the merits of saving aggressively. Offthegrid wrote, ‘Not enough education or attention is given to the power of investing when you are young.’”

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It’s time to change that by making financial education part of every child’s school experience. In the meantime, start a family 401(k) for your kids. Even a modest annual contribution can lead to big savings over 50 years. It also sets a good example.

16 comments
walstir
walstir

“few stuck to any rules of thumb, like saving 10% of pre-tax income each paycheck”

This is one of these sensible rules (like sensible eating or exercising) that would have disastrous economic consequences if everyone started following.  They are only beneficial when adopted by few.

Jill Louis
Jill Louis

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JR6862
JR6862

I think it's beneficial to contribute to a retirement plan like a Roth IRA or a 401(k), especially if you can reduce your taxable income. The IRS offers a Saver's Tax Credit, which does just that: 

http://www.efile.com/tax-credi...

JR6862
JR6862

I think it's beneficial to contribute to a retirement fund like a Roth IRA or a 401(k) plan, especially if you can reduce your taxable income. The IRS offers a Saver's Tax Credit, which does just that: 

http://www.efile.com/tax-credi... 

Firozali A.Mulla
Firozali A.Mulla

If the true value of money is lost then even if you have save millions from 50 the prices of al commodities have soured so hugh that you will be lucky to have any saving now I thank you Firozali A.Mulla DBA

VIkMeh
VIkMeh

This biggest fallacy of the whole math in the article above is 7% annual growth.  Where did this 7% come from?  The average annual growth is more like 3% for the past 20 years.   

 And then you factor in inflation.   When annual growth is high, inflation is high,  which almost negates the affect of high returns.  

In a long term (40+ years), you will be lucky if your money can just keep -up with inflation. 

But what I am saying is it doesnt matter very much if you save 100 $ today or equivalent of $100 20 years from now.  

Also what I am saying is that the idea of retirement is just plain wrong.  The math of retirement will never work. 

If you plan on not working for 35 years (age 65-90), then you have to save 50% of your income for 35 years (30-65),  Assuming that you earn just enough interest to keep up with inflation.   And also assuming that your cost of living will be same when you  are 80 as it was when you are 35.

Can you save 50% of your income just for retirement? No. 

So the idea of retirement is just plain wrong

Nonaffiliated
Nonaffiliated

The idea of retirement is not wrong.  It's working for me.  Invest in something like DIA that has low expenses, decent yield, and no long-term risk.  Invest 10% of your income, even when the market is down (especially with the market is down!) and you'll do fine.  

Look at the last 10 (very bad) years.  DIA's cumulative total return over that period is a bit over 67%.   Cumulative inflation over that period is only about 25%.   That's about 4.3% over inflation per year during one of the worst investing periods ever.  Over a 35 year period, you'll meet or exceed the 7% mark.

VIkMeh
VIkMeh

In many countries where the %age of people above 65  is growing,  even if everyone saves money,  who will use that capital to give you returns.   

By simple math, the idea of retirement as a social policy is not going to work. 

The age of retirement was kept at 65 because the average age of people was 62.  The idea was a lot people wont even need to use the savings.  

Nonaffiliated
Nonaffiliated

You're oversimplifying.   Just because people live longer doesn't mean they can't retire.  Some will continue to work because they want to.  Some nations still have a surplus of workers in need of capital (which our retirees could provide).  In fact, we still seem to have a surplus of labor here in the USA (8% unemployment).  As technology advances, a lower ratio of workers to retirees may be supportable. 

Of course, there's a limit.  However, if too many people try to retire too early, the price of labor would go up and entice more folks back into the workforce, re-balancing the equation.

I don't see retirement as a "social policy"; it's my personal policy.  If you don't want to retire, more power to you!

VIkMeh
VIkMeh

Not everyone will make money by investments.  Infact most part-time investors will loose money. 

Just imagine, if everyone was investing in DIA, do you think DIA investments will make money or loose money. 

That said, I am not saying dont invest money.  I am all for diversified investments. That is what I do too.  

But if you plan that your investments will always return 5% over inflation in the long run,  more than 50% of the people will not meet that goal. 

So as a policy getting 5% on retirement savings is bad planning.

educatingtheuneducated
educatingtheuneducated

3%??? I am 30 years old and have put aside 90 thousand dollars for retirement, I started saving when i was 23. I have invested in the most aggresive funds that have been available to me, and after 8 years the balance in my retirement account is.... 98000 dollars. And most of that 8,000 has just been in the last two months. There were times this summer where I stood at a few hundred dollars in interest made over 8 years.

Ive learned about markets and funds and invested in well diversified solid enterprises, but when the market loses 10 to 20% of its value in a week its impossible to move your money that fast to keep ahead of it. I would LOVE to get 3% of a return.

educatingtheuneducated
educatingtheuneducated

3%???  I am 30 years old and have put aside 90 thousand dollars for retirement,  I started saving when i was 23.  I have invested in the most aggresive funds that have been available to me, and after 8 years the balance in my retirement account is.... 98000 dollars.  And most of that 8,000 has just been in the last two months.  There were times this summer where I stood at a few hundred dollars in interest made over 8 years. 

Ive learned about markets and funds and invested in well diversified solid enterprises, but when the market loses 10 to 20% of its value in a week its impossible to move your money that fast to keep ahead of it.  I would LOVE to get 3% of a return.

Reader_78432
Reader_78432

I'm in my early 20s and was able to open an IRA in March this year with $1000. In 6 months, it has grown to $1000.22. Where is this 7% annual growth if I'm only on track to make 44cents in interest this year? Could someone explain that? I really don't know. Thanks.

Gillian Money After Graduation
Gillian Money After Graduation

It is imperative for young people to start saving early. I am putting away money now (at 25) and it means I'll never have to put a large percentage of earnings into savings, simply because interest will be compounding on the money. 

CrankyFranky
CrankyFranky

 yeah except imperative varies with age - teenagers' imperative is to fit into a peer group, 20's imperative may be to impress a potential mate, 30's imperative may be housing and feeding extra mouths (one income per person becomes one income for 3 persons!), 40's imperative may be paying off a mortgage or running a business, 50's imperative maybe OMG - save for a looming retirement!

I have seen professional advisers suggest - when you're young, go out and spend your limited funds on having fun and gaining experiences - this is normal and should not be denied so you can save up for 40 years time - what if you get hit by a bus tomorrow - you don't wanna be the richest person in the cemetery !