Dialed In

Jonathan Clements

HOW DO WE GET FROM here to retirement? Amid the financial markets’ daily turmoil, it might seem like one big crapshoot.

But in truth, navigating this journey is pretty straightforward, because there are just five key variables—our time horizon, current nest egg, savings rate, target nest egg and investment return. With a few tweaks to these “dials,” we may discover it’s far easier to reach our retirement goal. Which dials are most effective? Much depends on how close we are to retirement age.

To get a handle on the issue, imagine the goal is to retire at age 65 with today’s equivalent of $1 million, which should be enough to kick off $40,000 in retirement income, assuming a 4% withdrawal rate. After adjusting for inflation, let’s also assume stocks earn 4% a year and bonds 0%.

That brings us to our base case: We begin investing for retirement at age 25 with a mix of 60% stocks and 40% bonds. We sock away a little over $15,000 a year, with that sum rising each year with inflation. If all goes well, our nest egg should—in today’s dollars—be worth some $169,000 at age 35, $384,000 at age 45, $655,000 at 55 and our coveted $1 million at 65.

Boosting returns. Does saving $15,000 a year seem too onerous? Remember, while I’m assuming that we step up the sum we save each year with inflation, our ability to save should rise faster than that over our career, as we get pay raises that outpace the inflation rate. The upshot: Even if we can’t hit $15,000 in annual savings during our initial working years, that target may be much more manageable later on.

Still, if we want to dial down the required annual savings rate, the No. 1 thing we can do is raise our portfolio’s expected investment return, especially if we’re early in our career. We can do that by cutting investment costs and making the most of retirement accounts. But the key step is to allocate more to stocks. For instance, if we opted for 80% stocks rather than 60% from the get-go, the required savings rate starting at age 25 drops from above $15,000 a year to around $12,700.

Meanwhile, if we’re closer to retirement, continuing to invest aggressively can also pay handsome dividends—assuming the stock market performs as hoped. But for market returns to be a big help at that late stage, we need to have been good savers up until that point, so we have a plump portfolio to benefit from those expected higher stock returns.

If we haven’t been such good savers, investment returns become less crucial. Let’s say we’re age 50, have $100,000 saved and hope to hit $500,000 by age 65. Even if we hold 80% stocks rather than 60%, that only trims the required annual savings rate from $20,000 to $18,000. On top of that, there’s a greater danger of disappointing investment returns, given the relatively short time horizon.

Delaying retirement. So what’s the best strategy if we’ve been tardy with our retirement savings? We might postpone retirement from, say, age 65 to 67. If we’re age 50, with $100,000 saved and $500,000 desired at retirement, delaying retirement by two years trims the required annual savings from $20,000 to $17,000. What if we both delay retirement by two years and hold 80% stocks, rather than 60%? That cuts the necessary savings from $20,000 a year to below $15,000.

While a two-year retirement delay can be a smart move if we’re late to the savings game, it shouldn’t be necessary if we’ve been good savers for much of our career—and it probably won’t make that much difference to our required savings rate. With 60% in stocks and a $1 million goal, our hypothetical 25-year-olds still need to save $14,000 a year if they delay retirement from age 65 to 67—or, alternatively, if they start saving at age 23 rather than at 25. In other words, toughing it out in the workforce for two more years only cuts the required savings rate by roughly $1,000 a year.

I’m not arguing that $1,000 less per year isn’t meaningful. But if we’re already saving for 40 years, tacking on an extra two years is far less crucial than it is for those who start late. Don’t want to delay retirement past age 65? Do the obvious: Save diligently in your 20s and early 30s. Indeed, if we don’t start saving until age 35 or so, postponing retirement by two or three years may be our only choice if we want a financially comfortable retirement.

Trimming the target. If we start saving late in life, we’ll likely need every dollar we can amass—and we’ll probably end up with far less than $1 million. By contrast, if we start saving diligently at age 25, we might discover we have more than enough for a comfortable retirement, especially once we factor in Social Security.

For instance, imagine we began saving $15,000 a year at age 25 and got to 55 with the $655,000 nest egg mentioned above. And then—bam!—we’re laid off, or we decide to go part-time, or perhaps we want to pursue a different career. Whatever the case, we end up with a lower income and hence less ability to save.

What to do? To hit our $1 million, we could invest more aggressively or delay retirement by a few years. But perhaps the wiser course is to lower our target nest egg from $1 million to $900,000. If we do that, the required annual savings rate over our final 10 years in the workforce drops from $15,000 to just $6,000.

One final scenario: What if we want to retire early? If our goal is $1 million and we hold a 60-40 stock-bond mix, we could retire at age 58 if we save $20,000 a year starting at age 25, with that sum rising each year with inflation. What if we save that $20,000 a year, while also holding an 80-20 portfolio? If the markets perform as expected, we could potentially retire 10 years early—at age 55.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Ain’t EverythingBad Influence and Never Assume.

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JDave Foster
JDave Foster
2 years ago

40% bonds at age 25? Your investor will be forgoing a LOT of appreciation over the next 40 – 70 years. Vanguard Target Retirement 2060 is only 10% in bonds, and it’s debatable whether a 25 year old should have any of their retirement savings in bonds. It’s not like they are going to need to cash out over the next 5 years.

2 years ago

Of course, if you are a 2 income household and do the same, you’re cutting the time by more than half – given more money invested initially over the same length of time.

But I am curious what you think of the 1 million mark. I read someplace else that 2.7M is the new 1M. I guess the question is more philosophical – should one work longer? What does it say of work and folks, if folks continued working to escape boredom?

2 years ago
Reply to  gofi

You raise some great points! I think working part-time in retirement is good if it helps with boredom, helps with socializing, and helps with connecting with others. I think if the focus is on money that it is somewhat a slippery slope. I know a few people that work part-time and use the money as their “play money”, money outside the regular budget that they use for expensive hobbies and such. I think the danger is when you truly need it as a required part of your budget. An illness or “life in general” could remove that position and there isn’t a lot of great options as one ages.

I think the $1 million-$2.7m conversation is getting to the end without addressing the beginning and middle. How much will you needwant per year in retirement? For me, that number is $100k per year. My life expectancy estimate says I could live to 92 and my wife 96, so we’ll need roughly 36 years of that $100k. Of course, as we age the need for that $100k will decrease, but this is an estimate so I’m sticking with that number. Inflation is a factor, so that $100k will buy less and less over that 36 years. My wife and I both have a pension with COLA, so part of that $100k is offset by our pension as well as our social security, so I really don’t need to have saved up enough for $100k per year for 36 years…now I only need to have saved up $35k a year for those 36 years. On the surface I needed $4 million to fund my retirement plus have a buffer, but with dual pensions and SS, I now only need ~$1.3 million. Fortunately, I have more saved than that so there is a safety net as well.

My entire point is to figure out what you want your retirement to look like, and then see if your circumstances can support that desire. Maybe you do need only $1 million…….or that $2.7 million is more accurate. Don’t just chase a number, but figure out what that number should be and then focus on that goal. Revisit that number as you age, as expectations change as well as life’s setbacks throw a wrench into things.

Roboticus Aquarius
Roboticus Aquarius
2 years ago
Reply to  IAD

Great example! I find that annual cashflow analysis is really helpful to frame the discussion when I look at my own situation.

Two wild cards in the discussion are SS and medicare… if you are delaying until age 70 to collect SS, then you have to factor in additional demand on your savings from your retirement date to age 70, and medicare from retirement date to age 65 for basic insurance coverage. This means that working backwards off the 4% rule is not sufficient… one also has to consider additional cash flow demands until these programs kick in. I suspect in your case, perhaps $1M of your $1.3M funds your ~$36K/year + inflation ongoing, and the $300K is filling the gaps to get to SS and perhaps medicare.

Beyond that, illiquid assets like property or a business or even an inheritance may have a highly variable payout depending on a host of factors. It means I really need a large safety factor if I’m counting on these cash inflows to help fund retirement, or else plan without them and treat them as my safety factor.

2 years ago

I’m 66. I made many of the classic mistakes along the way. Forced early retirement at 56 after a 30 year career. I took umbrage at that and decide to stay retired. No company paid health insurance. Carried a mortgage. Took SS at 62. My saving grace was diligent saving. Max out the 401K with dollar for dollar match. Save more in IRAs and Roths plus emergency funds. At first I was 80/20 and gradually moved to 60/40. I started saving at 30 with $2000 per year and increased it every year up to 50K. I’m not rich but very comfortable. Saving was the key lever for me giving me the option to retire early.

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