by Joe Mont
There shouldn't be any harm in finding ways to simplify the complexities of retirement planning.
Over the years, much advice has drawn upon "magic numbers" touted as simple guidelines and goalposts for investors.
Those cookie-cutter bits of wisdom, however, hardly reflect the changing face of retirement, an evolution charged up by the millions of Baby Boomers who are just now reaching retirement age. Some may be downright dangerous to follow. Here are some common measures and how they stack up.
The Magic Number: 70%
What It Means: Plan to spend 70% of your current income in retirement. For example, if your pre-retirement income was $100,000 a year, spend $70,000 in your golden years.
What's Wrong With It: People are living longer than ever. (The life expectancy in the U.S. is 78.4.) With a company pension, you may be set for life, no matter how long you live. With direct-benefit plans giving way to employee-managed 401(k)'s and IRAs, retirement savings has become finite and the risk of running out of money as you grow older becomes very real.
That is not to say you should live out your remaining days as a penny-pincher. But it does mean that you need to individualize your game plan.
Do you come from a family with some members who have lived into their 90s? Do you have an illness that may someday require long-term care? Those and other personal factors need to be among the many things to think about as you assess your post-retirement spending habits and investment strategies.
The Magic Number: 4%
What It Means: This is another spending guideline. It suggests that a retiree spend an inflation-adjusted 4% of his or her total retirement assets each year, keeping the balance invested with a mix of stocks and bonds.
What's Wrong With It: No less an authority than Nobel laureate William Sharpe, professor of finance, emeritus, at the Stanford Graduate School of Business has written extensively about this "rule" and why it can ultimately be harmful.
The rigidity of the spending plan is among its problems. If a portfolio underperforms, staying the course is a clear path to running out of money. When returns are better than expected, there is an unspent surplus.
Sharpe offers an alternative to the 4% rule. Instead, invest in TIPS (Treasury Inflation-Protected Securities). If those returns prove insufficient, an investor can always dial up portfolio risk and seek better returns.
The Magic Number: 62
What It Means: The earliest age that one can start collecting Social Security benefits (at reduced levels). It is also the average retirement age, according to the U.S. Census Bureau.
What's Wrong With It: Working longer not only allows you to earn full benefits (the threshold for which has steadily crept up to 66 in recent years) but a few extra years on the job means more salary to tuck away and a healthier 401(k) or IRA.
The Magic Number: 1 million
What It Means: The number of dollars many advisors offer as a retirement savings goal.
What's Wrong With It: When we last tackled this topic, it generated a boatload of angry responses. Times are tough and the last thing folks wanted to hear were advisors' warnings that even $1 million may not be sufficient.
The initial story focused on a poll of registered investment advisors by Scottrade. It found that 71% of them don't believe $1 million is enough for the average American family. Most said families need to save double, or more than triple, the amount.
A great many readers raised two common arguments: that financial advisors are in the business of getting you to invest more, so of course they want to up the ante; and times are tough and there is no way that most families can save even close to a million bucks.
An Employee Benefit Research Institute study of self-directed retirement plans bears out the latter talking point. It found, for example, that those between the ages of 55 and 64 averaged only $69,127. We've seen other studies that move the mark even lower.
Both sides make valid points. With longer lives, inflation and rising medical costs, the advisors who were polled may not be all that reckless. After all, it wasn't a question of what families can save, rather what would be ideal.
To those on the other side, it's probably true that the vast majority of us will find a way to make due with far less than what was suggested. To sum up the good advice posted by commenters, paying off your mortgage and debt, staying away from credit and luxury spending, and maintaining a diversified and balanced investment portfolio are ways to ensure sufficient retirement savings.
-- Reported by Joe Mont in Boston.