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Years ago, one of the largest investment firms had a campaign revolving around knowing “your number.” The idea was that people were supposed to know the exact amount of money they needed in order to retire. For instance, if “your number” was $2,345,678, you could theoretically retire when you accumulated that much money. It probably doesn’t surprise you to learn it’s not that simple.
Funding a retirement is an incredibly difficult task for several reasons, but the complicating factor I always return to is that we don’t know when we will move on to post-retirement. Post-retirement being death. And because we don’t know that, we don’t know what percentage of our nest egg can safely be withdrawn in any given year to ensure we don’t run out of money before the post-retirement thing. And because we don’t know that, we don’t know when we can retire.
And because we don’t know that, we don’t know how much to save in any given month.
Therefore, calculating “your number” is incredibly complicated.
Just think about all the variables that go into this calculation. There’s your demand for money (lifestyle), there’s your pre-retirement rate of return, your retirement rate of return, inflation, your distribution rate, your tax rate, and how many years you plan to take income. All these variables help determine how much money you need to save (invest) this month, in order to hit “your number.”
Even though I believe the operative problem is not knowing your date of death, you really shouldn’t try to begin to solve the retirement math problem with that particular variable. In fact, turning your attention to several of the variables I listed above will lead to a dead end. Pun intended.
The challenge for most people, to no surprise, is focus. With so many variables, they don’t know what variable to focus on. Often, people choose to focus on investment returns, tax rates and inflation. When, in reality, they’re much better off focusing their attention on lifestyle, the actual day they want to retire, and the amount they’re saving (investing) each month.
I’m not suggesting you shouldn’t try to lessen your tax burden, improve your investment returns, or guard against inflation, but I am suggesting those are strategies, not behaviors.
The best way to get to “your number” is to first pick a retirement year. Ideally, the year you select takes into consideration other income and expense milestones. On the income side, a milestone might be when you reach Social Security eligibility, pension eligibility, or even age 59-1/2, which makes your qualified (retirement) more easily accessible. On the expense side, a milestone might include becoming eligible for Medicare or paying off your mortgage.
Once you pick your retirement date, you need to determine how much income you’d like to live on, starting that day and beyond. In case you’re wondering, this is where having an unrealistic view of your own behavior becomes a major problem. Unless you’ve successfully lived a lifestyle based on your projected retirement income, it’s really hard to suggest you’ll be able to do it years from now, cold turkey. Yes, I’m suggesting a budget would come in handy here.
At this point, your financial adviser will likely factor in taxes and inflation, to make sure you don’t fall short of your mark based on your future tax obligations and a loss of buying power. She then will help you decide how aggressive your draw-down strategy will be in retirement. This is where your projected date of death comes into play. If you choose to play your withdrawal rate (the amount of income you take from your investments in retirement) conservatively, your age of death will be less of a factor, because you won’t eat into your nest egg as quickly. If your lifestyle needs are too great in relation to your projected retirement-asset balance, you might be forced to aggressively draw down your assets, thus introducing the risk of living too long.
You are now prepared to receive “your number” from your adviser. It will be bigger than you thought, and it will distract you, if not cause a bit of paralysis. Your goal at this point is to ignore “your number” and instead turn your attention to how much money you need to save (invest) on a monthly basis to hit “your number.” Then either commit to saving that much each month, or immediately get a new number and accept the consequences that come with it.•
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Dunn is CEO of Your Money Line powered by Pete the Planner, an employee-benefit organization focused on solving employees’ financial challenges. Email your financial questions to askpete@petetheplanner.com.
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