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Like most people, I’ll get to feeling overwhelmed. Too many choices, too much complexity, just too much. Once the overwhelm kicks in, there are two ways forward; take a big deep breath and calmly work through the issue, or simply put the whole thing aside. I would like to think that I do more of the former, but as a human being, sometimes it’s the latter.
And it worries me that when financial advice is broadcast to a wide audience, the vast majority will feel their heads spinning. Like most people here as part of the Humble Dollar community, I would like to think that I’ve got a good grasp of the basics. But when the discussion turns to tax efficiency, sequence of return risk, inflation hedges and myriad other topics, I can be left feeling a little dazed. So I can just imagine how Joe or Janet Average might feel trying to get their head around these issues. Once Janet or Joe is feeling thoroughly confused, I suspect that it all gets too hard and they take no action to improve their financial situation. In fact, they may even do the opposite and gravitate to a seemingly simple scheme that is “too good to be true”, and destroys their financial health.
Specifically for retirement preparation, I tend to think that society as a whole would be well served with a very simple approach. Something like:
– Put 12% of your wage, or as close as you can possibly get, into a target date fund.
– Keep doing this until retirement age.
– Once in retirement, always have 3-7 years worth of spending into a high yield savings account. Avoid topping this up on years when your index funds are down.
– Keep the remainder in a suitable mix of fixed interest and globally diversified index funds.
Now, please feel free to argue with me about my particular plan. I’m no financial oracle (obviously) and won’t claim to have the final answer on this. And this plan will not optimise the outcomes for an individual. But I would argue that if the plan is going to be reasonably good for the vast majority of the population, and is sufficiently simple so that people can grasp it and feel comfortable actually implementing it, that it would provide vastly better outcomes for a huge proportion of society.
Could a plan outlined in just a handful of dot points be perfect? No. But could it have a massive positive impact on retirement outcomes? I think …. yes.
This is a straightforward yet effective plan that is accessible to many workers’ retirement objectives. In addition to setting a savings target, it’s important for savers to have a good sense of essential and discretionary expenses during their working years.
We hoped to retire at age 65 and to be able to continue our standard of living after the paychecks stopped. To do so, we chose a lifestyle which was suitable and allowed us to invest a significant amount. This meant our eventual target number would be more achievable and amassed sooner, than if we had lived a more expensive lifestyle. We are now in our eighth year of an enjoyable retirement. Did we succeed because we were brilliant investors? Not hardly. The secret sauce was living below our means, avoiding or minimizing debt and investing the difference, and a little luck along the way.
It may not be too late for younger households, but many older ones will need to shift to a less expensive standard of living when they retire and/or delay their retirement, assuming they are able to continue working in old age. Worse, some of them may be tempted to invest in riskier assets, which is bad because no matter what their risk tolerance may be, their capacity to take risk is low to non-existent.
Your advice is sound. Unfortunately, we know from real life that too many will be unprepared.
Greg, from my abbreviated career in financial services, I can say with certainty that the head spinning information overload that causes many people to freeze up, and take no action at all, is a very real thing.
What kinds of insurance do I need? Insurance companies have mastered the art of making simple products such as term life policies and fixed annuities, complex.
What do I invest in? Investment companies now confuse us by offering some bizarre Exchange Traded Funds. Here are a few examples: pet care (PAWZ), space commercialization (UFO), vice industries like tobacco and gambling (VICE), livestock futures (COW), and political trading habits (NANC/KRUZ).
There are some bright spots that I think will benefit younger workers. Auto enrollment in defined contribution plans, and Target Date Funds to name a couple.
But for me, I think I’ll go all in on VICE!
With more than half the population living paycheck-to-paycheck, your idea isn’t going to work. Which households have 12% margin in their budgets?
What we could do is to match your investment choice with a mandate for ALL employers to fund additional pretax compensation of say 5-7% which would be contributed to a governmental program which would invest these funds as you have suggested. Employers could increase their prices to offset the additional expense. Where ever people worked their retirement account would follow them. Employees who wish to contribute more could do so. There would be some initial angst from employers but they would adjust.
When retirement funding is optional it does not occur for most of the population.
That’s roughly how it works in the UK. Employees are automatically enrolled in a workplace pension scheme, with 5% deducted from their pay and a legally required 3% added by their employer — a total contribution of 8%. The account belongs to the individual and moves with them as they change jobs over the years. Not a perfect system, but 8% is better than nothing.
No access to the account is available until age 57.
That sounds good, but does it work for part-time employees? Some companies offer fewer hours to avoid paying benefits. Also, employees of companies like Uber are classified as “independent contractors”, not employees.
Good point. When I ran the scheme for my employees, the first 6k of earnings was excluded — only the balance above that threshold counted for pension contributions. I also recall receiving communications from the tax authorities before I sold the business, flagging that the 6k exemption was being removed specifically to bring more part-time staff into auto-enrolment. Being out of the loop now, I’m not sure whether that change has actually taken effect yet. As for contractors, my suspicion is that remains an unresolved issue.
I think your plan is a good one. Perhaps the most difficult part is saving. It was for me. I began working and saving in high school. 50% of my net wages went into a savings account. The rest went to school related expenses.
I continued saving until the age of 30. My employer also had a profit sharing plan, which was before the existence of IRAs, 401(k)s, etc. After marrying, a portion of my savings went into the down payment for a house and paying off my spouse’s college debt. Money was also set aside for college for the children. I was saving a significant amount, but most of it wasn’t going toward my retirement. That can be a problem.
At the age of 54 I was starting over. My savings were zero, but the children had all finished college. I state that here because I was able to resume saving, and I did eventually achieve a significant retirement account. But I did have to work longer than many. At the age of 67 I began a “phased” retirement, with a gradual reduction in hours worked each year. I worked part time for a number of years, continuing to contribute to my IRAs. I did finally, fully retire in my 70s.
My point is, we can have plans and good intentions, but circumstances can intervene. Nevertheless, it is possible to plan and prepare for retirement, no matter what those circumstances are.
Greg–great article! I think your advice is spot on.
If I were to add any type of additional advice it would be something along the lines of “Live within your means” or “Try to avoid unnecessary debt”. Of course, what is ‘unnecessary debt’ to one is essential to another.
Perhaps a better way to phrase it would be to ‘try and live a lifestyle like it’s thirty years ago’.
It seems like the expectations of a ‘good’ life have vastly exceeded the growth of (most) wages over the past thirty or forty years.
I didn’t own a car until I was in my mid-twenties (and gainfully employed). The first house I owned was an 800 square foot ‘fixer’. When I was growing up, ‘eating out’ meant getting a hamburger and box of cookies from McDonald’s. Vacations consisted of camping for a week or two and sleeping in a tent.
Lifestyle creep is real and it seems like it can become an excuse for why people can’t set aside any money for retirement.
Kristine ….spot on. I see lifestlye creep with my 2 boys & their significant others. All with new leased cars as opposed to buying a older used car. We live approx. 12 miles from Manhattan. Bus stop 5 minute walk from our townhouse. NJ Transit bus to midtown $9.50…..Uber usually $50’ish to $65.00 each way. They Uber it. Food shopping – the one significant other doesn’t like it. Instacart or a similar service. Multiple vacations to the Caribbean, Mexico or Europe yearly. At this point I can’t imagine either owning a home. They all make what I would consider relatively good money. The downside is we live in a very pricey area. Keep hoping they will wake up!
Yep–it seems like each generation believes in a higher standard of living is necessary.
I went to a state university for my BS degree. I lived off campus and rode my bike to school every day. I didn’t own a car. My first job (which I stayed at for six years) was at a medical school. A parking spot cost $100/month back then. I was making about $16,000 a year so paying for parking was out of the question. I rode public transit to and from work almost every day for those six years. Sometimes, if the weather was really nice, I’d walk home instead.
I never made more than $74,000 a year in thirty years of working. Yet I was able to retire at 55. Lifestyle choices and luck both played a role in making that possible.
“It seems like the expectations of a ‘good’ life have vastly exceeded the growth of (most) wages over the past thirty or forty years.”
I call this the social media effect.
Indeed.
“Keeping up with the Joneses” once meant comparing yourself to your neighbors or a handful of co-workers.
These days you get to compare yourself to millions of people (real and fake) from all around the world.
And your comment is spot on.
Thanks!
Greg, great article and genuinely sensible advice. The elephant in the room, though, is hard to ignore: for a large portion of the population, putting aside 12% — or anything close to it — simply isn’t possible. When you’re living payday to payday, retirement savings isn’t a choice, it’s a luxury. That’s a societal problem, not a flaw in your thinking.
Greg, for the many folks who fail to do any retirement planning, I think your simple steps would serve well. I started with just half of it: saving and investing in stock-mutual funds. But there is more to learn, and to finance what we hope will be two or three decades of our life, we probably should give a little more effort to learn more. Like how to keep that pile of money we’ve accumulated.
“But there is more to learn, and to finance what we hope will be two or three decades of our life, we probably should give a little more effort to learn more.”
I think this is a result of failure to cover this material in high school.