Saving for Retirement: A Primer

Steven Beck, AWMA, AIF

June 5, 2019

I came across a survey last week that both startled and inspired me to write this article: According to Northwestern Mutual and reported by thestreet.com earlier this year, nearly 1/3 of all working Americans have less than $5,000 in retirement savings. In addition to that, 1/3 of all baby boomers, either in or approaching retirement, have less than $25,000 saved. With the average social security recipient receiving $1,461 according to USNews, someone retiring at their full retirement age of 66 with $25,000 in IRA/401(k) funds would need to live off $1,577.67 a month, without much room for error, or accounting for taxes or inflation.  Assuming an investment growth rate of 5% in retirement, you will need approximately 12 times your annual expenses to survive retirement over a 30 year period; which includes receiving average social security benefits. Put another way, if you’re pre-retirement expenses are $75,000 annually, you may need a minimum of $900,000 saved before even considering retirement. With advances in technology, medicine, and increasing longevity, I would say this should be the minimum expectation of savings.

How does someone save nearly $1,000,000? As the saying goes with any seemingly insurmountable hurdle, one step at a time. There are only three inputs to calculating the potential future size of your investment portfolio: time invested, amount invested, and rate of return.

How long do you have to invest? Generally speaking, the longer, the better. A longer time frame allows you to take advantage of compounded interest, a key to investing. Compounded interest is simple to explain, but its power is often ignored or misunderstood. Compounded interest is the money you make off the money you made. Sound confusing? Let me explain: Say our investor starts with $1,000, and, for ease of calculation, let’s assume his annual rate of return is 10%. After one year he will have $1,100 ($1,000 x 10% growth). After year two, he will have $1,210. The extra $10 is the income generated on the first year’s $100 growth ($100 x 10%). You stack that up over the years and the potential for growth is significant.  After ten years, our investor’s $1,000 turns into $2,593. After 20 years, $6,727. 30 years? $17,449, all from the initial $1,000 investment!

Now that we’ve established the importance of time, let’s turn to the second aspect of saving: contribution amounts. Our last example was assuming our investor starts with a $1,000 initial investment and doesn’t contribute throughout the years. The key is time frame AND contribution amounts. Assuming the same scenario, let’s say our investor decides to contribute $100 a month beginning year one. In ten years, they would have $23,631. At the thirty year mark, our saver is expected to have $234,581. Assuming a 30 year retirement and a 5% average annual rate of return during that period, his $100/month contribution has turned into $1,166/month in retirement income!

Time and annual contribution amounts are inputs that can normally be controlled by the investor. The last input, rate of return, is more difficult. While the investor or financial professional can help influence this input by suitable asset allocation and active investment management, there are an infinite number of externalities and exogenous events that can and will happen that can alter rates of return, for better or for worse. But the one area investors and their financial professional can control is choosing appropriate investments based on his or her risk tolerance and time horizon. If our investor does not have the time frame or risk tolerance to be invested in the stock market, they may want to stick to bonds or money market accounts. An example I’ve been fond of using with my clients over the past few years is the Great Recession of 2008-09. If our investor were to invest all their funds in the S&P 500 (or an index fund that mirrors the S&P 500, you can’t invest in the index itself) at the peak in October 2007 and, due to fear or a shorter time horizon, exited the market five months later, he would have lost 53% of their investment. Now, let’s say this individual was more risk tolerant and had a ten year time horizon. With the exact same investment, but a ten year time frame, our investor would have a 65% gain by October 2017 instead of the 53% loss. In dollar terms, that’s the difference of your $1000 dropping to $470, or increasing to $1,650.

Together, these three inputs determine how much you could accumulate towards your financial goal, retirement in this case.  With the Social Security Trust Fund benefit payouts exceeding incoming revenue by 2020 and the complete depletion of the fund by 2035 according to Barron’s, a highly regarded financial periodical, it makes sense that Americans begin preparing for their own retirement income and not count on or depend on this system, which is in desperate need of substantial change. Now, I am not suggesting that Social Security will not be around in 20 or 30 years, but what the system will look like then is anybody’s guess. Raising the retirement age, as they have already done in the past, decreasing benefit amounts or annual COLA (Cost of Living Adjustments), or lifting or eliminating OASDI (Old Age, Survivors and Disability Insurance) tax caps are just a few of the alterations that may come to pass in the next decade, as politicians and citizens alike grapple with the new reality of Social Security deficits. A consistently slowing US birthrate only makes this inevitable, as older generations begin to constitute an increasingly larger percentage of the overall US population.

This article isn’t meant to scare anyone, but to hopefully awaken everyone, especially the younger generation, and spur them into action. Everyone’s financial situation is different, but, through careful evaluation of your own spending, I’m confident most can find an extra $50 a month to save. Whether it be a few less trips to Starbucks or making dinner at home instead of eating out a few times a month, start saving now, not tomorrow. Once you’ve established the habit of saving $50 a month, increasing to $60 the next year, or $75 the following, will seem like small and manageable incremental steps. In thirty years, I think you will happy you did.

_{Steven Beck is a Financial Advisor offering Securities and Investment Advisory Services through Waddell & Reed, Inc., a Broker/Dealer, Member FINRA/SIPC and Federally Registered Investment Advisor. He can be reached at sbeck@wradvisors.com  Loza, Beck & Associates is a name used by independent advisors associated with Waddell & Reed for marketing purposes. This material was created to provide accurate and reliable information on the subjects covered, and is meant for educational purposes only.  It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.  Investing involves risk, including the potential for loss of principal.  Using asset allocation as part of your investment strategy does not guarantee a profit or protect against a loss. The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. The examples do not represent any specific product, nor do they reflect sales charges or other expenses that may be required for some investments. The rate of return on investments will vary over time, particularly for longer-term investments. Investments that offer the potential for high returns also carry a high degree of risk. The value of debt securities (bonds) may fall when interest rates rise. For all bonds there is a risk that the issuer will default. Waddell & Reed is not affiliated with USNews, Northwestern Mutual, TheStreet.com or Barron’s.                                                     06/19}