Because you don’t have enough money — that’s why!
Okay, maybe that statement doesn’t apply to 100% of the people who might read this. But it applies to a large majority.
Most Americans don’t have enough money saved. One often sees stories in the news about how Americans don’t save enough, have too little in retirement savings, and won’t be able to support themselves in retirement. Many Americans don’t have any retirement savings of their own (not counting Social Security or pensions). For those that do, the average value of their retirement accounts is far too small to have much of an effect on their post-work lives. What about you? If you want to have any kind of life after you retire, you need to be very different than most of your fellow Americans. You need to set a goal and make it a reality.
What’s the goal? Simple: have a large sum of money when you retire. Your own money in investment accounts that you own. This is money that is separate from any Social Security, pension, or inheritance you might receive.
How much money? Some people* think you need savings that are large enough to be able to provide you an annual sum equal to your annual expenditures in retirement. Let’s say you retire with no dependents other than yourself and your spouse (kids, if any, are out of the house and self supporting) and you own your own home. Your expenditures are, basically:
- clothes and apparel,
- housing, furniture, and appliances maintenance,
- healthcare goods and services, and insurance,
- entertainment and vacations,
- everything else.
(Note that this is most likely a lot less than you needed when you still had to make monthly mortgage payments and were still paying room, board, education and all other expenses for dependent children. You also will also be spending less on work-related clothing and transportation.)
Let’s say all those expenses come to, say, $50,000 per year.
For how long? But how many years will you need to save for? If you knew for sure how long you would live after you retire, then it would be easy; say: 10 years at $50,000 is $500,000. (Actually somewhat less than that would be sufficient, because the bulk of that money can be earning dividends and interest while it’s waiting for you to need it. The fact that money can work for you will soon be very important to this discussion.) But of course, you don’t know how long after retirement you’re going to live, so it’s best to be cautious and plan for a long time, just to be safe.
How about forever? Why not save enough money to last forever? Remember that your retirement savings will be invested to earn dividends and interest. If your annual withdraw is less than the amount your savings are earning, then they will last forever — supporting you as long as you live.
How much to withdraw? All you need to remember is that 3% to 4% is generally accepted as the maximum annual “safe withdrawal rate” that will give you a near 100% chance of not running out of money for at least 30 years after retirement. (This assumes that your retirement savings are invested in either stocks or a mix of stocks and bonds.) This was first written about in a paper titled “Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable” (Philip L. Cooley, Carl M. Hubbard and Daniel T. Walz; AAII Journal, February 1998, Volume XX, No. 2. The authors were professors at Trinity University so their research is often referred to as “the Trinity study”; for more information, see Safe withdrawal rates on the http://www.bogleheads.org website). Of course, you don’t have to spend the maximum every year, and perhaps you shouldn’t if the value of your retirement accounts is declining during a bear market. Note that “3%” means you withdraw 3% of the value of your retirement savings the year you retire and then you withdraw that same amount (plus maybe a little more to adjust the amount for inflation) each year thereafter. It definitely does not mean withdraw 3% of the current value of your retirement savings every year!
So, how much do you need (again)? Withdrawing 3% per year means that your savings should be 33 times the size of the withdrawal you want to make. Withdrawing 4% per year means that your savings should be 25 times larger.
Do the math. Let’s assume you want to withdraw $50,000 per year from your retirement savings and do so every year for the rest of your life. The “safe withdrawal rate” rule says that you need something between $1.25 million (which is $50,000 × 25) and $1.65 million (which is $50,000 × 33).
More than a million dollars! Yes, that’s right. That’s your goal. So you better get started. But don’t let the number scare you. You won’t actually need to deposit one million dollars into your retirement savings account.
You need two things:
Money to invest. Time to allow your investment to grow. As years go by, you’ll see that your retirement savings account balance is far more than the sum of the deposits you actually made. The important thing is A.B.S. — Always Be Saving. When you’re young, you might not be able to save and invest large amounts, but what you do save will have the maximum amount of time to grow. When you’re middle-aged, you should be earning and saving more, but those savings have only a middling amount of time to grow. At the end of your career, you should be saving more than ever, but those savings have only a few years to grow. You need all three combinations of money and time to get to your goal: small amounts invested for a long time, mid-sized amounts invested for a middle amount of time, and large amounts invested for a short time.
It’s not as difficult as you might think. Surprisingly small amounts, saved monthly, invested to earn reasonable returns, grow to $1 million in just a few decades. There’s no sure and easy way to grow your retirement account to million-dollar size, and nothing is guaranteed. (Well, there is one guarantee: If you don’t save while you are working, you won’t have enough money when you retire.) If you start saving now and continue to save consistently, you have an excellent chance of achieving your goal.
Monthly Amount Needed to Save $1,000,000 by age 65
|Starting Age||Years Until Retirement||Annual Return on Investment
(all earnings re-invested and compounded)
As the table shows, if you start while you’re young, get reasonably good investment returns, and invest those returns the same way, you can get to $1 million by saving and investing a few hundred dollars a month. Make that your monthly goal. Reducing your spending by $5 to $10 per day through the efficient use of money takes you a long way towards your monthly goal. Once you get started you’ll likely want to save and invest even more, which means you will reach your goal even faster.
The table also shows how important it is to start ASAP. That means NOW. The longer you wait, the harder it is to reach your retirement-savings goal.
Here’s a chart showing the data from the final column of the table.
As shown in the table and chart: If you start before age 25, then saving less than $400 dollars a month (that same amount, every month, until age 65) has a good chance of growing to approximately one million dollars by retirement age. If you wait until you’re 35, then you’ll need more than $550 each month. At age 45, you need close to $2,000 each month.
So, to say it again: the time to start is NOW. Right NOW. Today.
Remember: Save as much as you can, as long as you can, and you have an excellent chance of reaching your goal. No one can guarantee that saving money like this will ensure that you have enough money in retirement (— but I do guarantee that if you don’t save then you won’t have enough money in your old age. Well, you might win the lottery or inherit a fortune from some rich relative, but do you want to stake your future on that?) If you get slightly better returns than are shown in the table, you’ll have well over a million.
Better than 7%? It’s hard to believe in this era of low interest rates, but it’s possible. You will have to invest in the stock market. That means invest in the stock market for a long time, leaving your money fully invested no matter how the market goes up or down. All of the returns (the dividends and interest your money earns) must be reinvested. You will need to spend as little as possible on the various fees that investment companies charge. Exactly how to do this is explained in J. L. Collins’ Stock Series.
How economizing can help. If your income is high enough that you can easily put the needed hundreds or thousands of dollars into your retirement savings account each month, then you don’t need what this website offers. If you can’t, then economizing (making the most efficient use of every dollar) and saving money (spending as little as possible) wherever and whenever you can is very important to shifting those dollars from consumption to savings. An important way of thinking, and a theme of this website is avoiding convenience. If you’re like most Americans and you earn a more-or-less average amount of money, then watching your pennies, nickels, and dimes is essential. What you eat for breakfast and lunch can go a long way towards the $10 or $20 per day that adds up to the $300 to $600 per month that grows to $1 million by the time you’re retirement age.
How to start: Read this post about The Richest Man in Babylon. Get the book. Read it. Let it inspire you.
* When I say “some people” I mean people who take a cautious approach to having enough money in retirement. That is, you’re going to save your $1 million or more and use it to provide for yourself after you’ve retired. This assumes you won’t get anything from Social Security, a pension, inheritance, or selling your house and moving into something less expensive and adding the capital gains to your savings. If you do get those things, so much the better. If Social Security and a pension cover your basic necessities, then your own savings can pay for a lot of extras. Or you might be able to retire early. Bonus!