Knowing, And Then Reaching, Your Target Number
So, this week I thought I would write this column for all those who are still in the accumulation stage of their financial lives, trying to determine their retirement number in the hopes of having the retirement we all have pictured for ourselves.
Folks, this is a hard question. I get it. For those of you who think you have a good idea of what that number is, how confident are you?
A recent Retirement Confidence Survey conducted by the Employee Benefit Research Institute found that two in five (thats 40 percent!) of those of us who are currently in the workforce dont know their number. Those who have calculated their number have determined that their number has to be north of a million bucks.
For some of us, that may seem high, but its reality for many people in todays retirement climate, especially when future needs are compared to current salaries. When I first started in this business, the school of thought was that a retiree could get by if he or she had saved enough to generate 70 percent of the income earned during his or her working years. In todays environment, many financial professionals believe that we need to save enough to generate 100 percent of our current income. I agree. For the most part, this shift can be attributed to a failing Social Security System and the significant rise in healthcare costs.
So heres the problem that Americans are facing. According to a 2016 report by the Economic Policy Institute, over half of all American households have less than $25,000 saved in their company retirement plans. This includes 26 percent of those who have less than $1,000 saved. In fact, the average retirement savings among American households is just $95,000, and that number is skewed based on the large savings held by the top 14 percent of families.
Hmmm . . .
You see, unlike with previous generations, for whom employers saved in the form of pensions, for the most part, unless you work for the federal or state governments, current and future generations must sock away most or all of the savings themselves.
Regardless of the exact figures, this leaves people significantly short of their big orange numbers. But remember, the most valuable asset we have in the accumulation stage of our financial lifetime is time. The earlier we start, the more successful we are in the long run. The obvious reason for this is that by saving sooner, there are more monthly periods to save, so the percentage of each monthly budget needed to put toward retirement is lower.
But the other compelling reason to start saving sooner rather than later is compounding interest. Wikipedia defines compound interest as, The addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest. It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously-accumulated interest. Essentially, the more time we have, the more time we give our money to grow.
Heck, even Albert Einstein chimed in on this one. He said, Compound interest is the eighth wonder of the world. He who understands it, earns it . . . he who doesnt . . . pays it. And he was a pretty smart guy.
Beyond simply starting early, there are a few other things that we can do to reach our target number even sooner; these things are especially helpful for those who are just at the beginning of their careers.
One of the most important things to do is to create a budget (I know, you Gary's Weekly Finance readers have heard me say that many times before). But I am serious. Outline monthly expenses, define discretionary income, and plan to put a specific amount toward retirement every month. And always pay yourself first! When your salary goes up or expenses go down, your retirement contributions should go up.
Once you start putting that money away, resist the temptation to borrow against it. Even if there is no upfront penalty for withdrawing, if you borrow against your savings, you miss out on the opportunity for that cash to earn compound interest and you could lose the chance to capture valuable market gains.
You should also take advantage of any employer-sponsored retirement plan as early, as often, and as fully as possible. If your company offers a plan, contributing to it is a great way to get started. If the plan offers a company match, thats free money, and free is the best four-letter word I know! You should try to contribute the full amount the company will match. If your company does not offer a specific plan for employees, do not let yourself off the hook here. Take the initiative to open and to max out a Traditional IRA or a Roth IRA.
Its important to remember that financial planning is not a set it and forget it strategy. Do not create your budget and then stick your head in the sand for the next few decades. As your financial situation changes, as the market changes, as your goals change, you should be updating your financial plan. Schedule an annual review with a retirement specialist to make sure you are getting the most from your strategy and are on track to meet your defined goals.
Lastly, I would be remiss to lay out a strategy to success without addressing how to avoid failure. The bedrock foundation of failure is procrastination. We have all done it, putting things off, delaying an action. Nope, not today. Anticipation is the ultimate power. Remember this: losers react; leaders anticipate. Lead yourself into a solid retirement.
Whats your number?