When making big financial decisions — a home, a car, college for the kids — you make must take into account how much income you’ll need for retirement. To put it bluntly: Retirement savings comes first, everything else second.
There’s no shortage of advice on saving for retirement, and an important piece of the puzzle is having a strategy to generate sufficient income when you stop working, as Andrea Coombes recently highlighted. One interesting statistic she cited was a survey showing that 63 percent of people ages 35 to 75 are concerned that Social Security or pensions won’t cover retirement expenses.
Do you think 63 percent is high? I find it surprisingly low, considering most people don’t have pensions and Social Security was designed to supplement other income in retirement.
The three big factors to consider when planning for retirement are: income, mortgage financing and a tax-deferred retirement plan, such as a 401(k). Other issues are important too, but if you can get those three right, you’ll probably be living well in retirement.
The Importance of Income
When planning for retirement, you might focus on the size of your nest egg as the ultimate goal. Some planners put the range at $1 million to $3 million. But that’s putting the cart before the horse. It’s much better to consider how much income you will need.
For example, a $1 million portfolio of investment-grade bonds in today’s low-interest-rate environment may yield 4 percent, or $40,000 a year. When adding Social Security, could you live off that? That might be enough if your financial house is in order, but if it’s not, the writing is on the wall: You need to save more.
Many retirement-advice columns emphasize the importance of “not outliving your money.” But saving up a nest egg and hoping not to outlive it is not a strategy. It’s wishful thinking.
Your goal must be to generate sufficient income with the retirement nest egg so you can cover your expenses, and even save money by spending less than you earn. Invest as if you are going to live forever. Why not? There will probably be at least one other person in your family counting on you not to burn through a lifetime’s hard work. With sufficient income, you will face the wonderful “problem,” when retired, of cash piling up.
The return on the $1 million bond portfolio may be disheartening, but it serves a purpose. It shows how easy it is to figure out how much money you will need. You can find higher-yielding investments, but you will then have to weigh the additional risk against the reward. In the end, it’s wholly possible to sock away a lot of money by controlling expenses.