Here's a question that every person planning for retirement should consider.
I have heard of several percentages of your present wages being required for retirement,
and also minimum nest egg amounts like $3 million. How would you evaluate these as true
requirements?
Most of you probably know the TV show "Who Wants to be a Millionaire?" I
actually had the
opportunity last week to meet the host, Regis Philbin, through a friend who works on the
show.
Introducing me to Regis, my friend described what my company, 401k Forum, does as
"making
millionaires the old-fashioned way, by investing their money." Although I really
liked that line (in fact,
I'm ordering bumper stickers), it is not entirely accurate. For one thing, if all we did
were to make
millionaires, we wouldn't necessarily be doing our job of preparing people for retirement.
Several factors are involved in deciding how much you will need to save before you can
retire.
How old are you?
At what age do you want to retire?
Will you receive any type of pension?
Most importantly, how much money do you expect to spend at retirement?
Different answers to these questions will result in widely differing estimates of how much
you will
need at the start of your retirement. For example, if you are 35 years old, plan on
retiring when you
are 60, will receive a $10,000 annual pension (quoted in today's dollars), and want to
live on
$70,000 per year (again in today's dollars), you will need a nest egg of $3 million, like
the one
mentioned in the question.
But if you are 50, plan on retiring at 65, will get a $20,000 annual pension, and can live
on $50,000
per year, you will need less than $1 million (Regis will be happy). On the other hand, if
you are 25,
want to retire at 55, have no pension and want $80,000 per year, you will need well over
$5
million!
The nest egg figures I quoted are all in future dollars, accounting for the growth of
inflation. They
look smaller if cited in today's dollars. But the point remains the same -- your required
investing plan
is a function of your personal goals.
When it comes to figuring out how much you should put away each year to accomplish your
goals,
things become even more complicated. It depends on the factors listed above, plus issues
such as
the amount your company is matching in your 401(k) plan, and the return you will earn on
your
investment. Of course, no one really knows that return -- we can make forecasts, but
forecasts can
be wrong.
So how do you get the answer that's right for you? One way is to use a retirement
calculator. These
generally allow you to plug in the various factors, such as inflation (I assumed 3.5%),
and the ever
friendly estimated age of death (I assumed 87). Using a calculator like the one on this
web site could
help you gauge how much to put away in retirement.
But I'll let you in on a little secret. I personally have never used a retirement
calculator to see how
much to invest each year. The reason is that many of the assumptions, such as inflation,
investment
return, and the date of my eventual demise, are out of my control. So what do I do? I
simply invest
as much as I can. I max out my 401(k), try to live within a budget, and store away as much
savings
as I can. It means foregoing the daily pedicure and missing out on the Brittany Spears'
concert, but
I'm a little more comfortable about the future because of it. I figure I'll determine how
much I'll
spend in retirement as I get closer to receiving that gold watch (wow, Timex! Thanks,
guys).
Hopefully this has given you some context for determining how much to save for retirement.
By the way, please don't hold the celebrity name-dropping against me. I'm an investment
nerd, and
usually the only well-known people I meet are other investment nerds. So when I meet a
famous
person who isn't an investment nerd, I'm starstruck.
Now, if I could just figure out a way to work Kathy Lee into next week's column...
On a different subject...about last week's market drop
The Dow Jones Industrial Average fell by 6% last Friday to close at 10,020. This means
it's fallen
12% since its high earlier this summer. As an investor, you have a right to ask what's
going on here.
First some perspective. If you invest in stocks, you need to expect some fluctuations in
values. One
out of every four years the market will lose money, and one out of every six years it will
lose more
than 10%. So why is it smart to be a long-term investor in equities? Volume! Volume!
Volume!
Specifically, investing a consistent proportion of your money in long-term stocks has
provided an
average return of over 10% per year since the mid-1920s. The word "consistent"
is in bold for a
reason. Investing an inconsistent proportion in stocks -- selling after the stock market
has fallen and
buying after it has gone back up -- has produced poor results. The point is, when you
invest in
stocks, you should do so with two intentions -- first that you have a long-term goal so
you can ride
out the dips in the market, and second that you will not sell your holdings after a market
dip.
To reduce the risk, you should diversify your portfolio -- across types of stocks, across
countries,
and potentially into safer fixed income investments. For example, the average
international stock fell
by less than 1% today, and while U.S. stocks have fallen this month, international stocks
are actually
flat. However, realize that diversification will reduce the degree of daily fluctuations,
but won't
eliminate them.
Finally, realize that the market is up for the year -- including dividends, the average
stock has risen
by 2.5%. You may have wanted better, because the outstanding market returns of the past
five
years has distorted your expectations, but 1999 has not been an awful year.
Why has the market fallen of late? Mainly fears of inflation and rising interest rates,
which depress
stock values. Friday's decline resulted from two factors: a 1.1% increase in the producers
price
index last month; and Federal Reserve Chairman Alan Greenspan's comments that investors
should
be prepared to withstand sharp short-term fluctuations in stock values.
There is no doubt that increasing inflation will make stocks less valuable. However, the
inflationary
pressures are caused by a booming economy, which over the long run is a good thing. The
Federal
Reserve Board has been very diligent about trying to keep inflation under control. As long
as they
continue their efforts, the long-term effects of inflation should be minimal. Meanwhile,
economic
growth will continue to cause corporate profits to rise, justifying investments in the
stock market.
For these reasons -- the overall economic outlook, the importance of maintaining a
consistent
investing strategy, and the long-term goals of retirement -- now is certainly not the time
to panic.
Your investment policy has probably made you a lot of money over the past few years --
don't
abandon it because of a few rocky weeks.  Lummer's
Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
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