What advice can we offer regarding the financial lives of the post-boomer generation – those who are in their 20’s and 30’s?
Start saving as soon as possible – every bit counts. Albert Einstein called the power of compounding the eighth wonder of the world. Consider the following example used by Keith Ambachtsheer, the renowned pension expert, as discussed in his book The Future of Pension Fund Management.
- Someone makes $60,000 a year, saves for 40 years of their working life, and lives in retirement for 20 years.
- They will need $40,000 (two-thirds of their salary) per year in retirement, a fairly standard assumption in the pension industry.
- $20,000 a year will be covered by social security.
- Savings will need to cover the remaining $20,000 per year for 20 years.
Here is where the power of compounding comes in. Let’s consider two cases – one where the return on the investment is zero, and another where the return is 4% per year.
Assuming a zero rate of return, our wage earner will need to accumulate $400,000 to fund 20 payments of $20,000 in retirement. This works out to be about 17% of their pay, which is pretty difficult, in our view.
In contrast, with just a 4% rate of return during both the 40 saving years and the 20 retirement years, our wage earner only needs to save 5% of pay during their saving years – a huge difference.
Like any example, this one raises many questions: Will social security still be available to GenXers and Millennials? What about people who live longer than 20 years in retirement? Can anyone afford to save for 40 years of their total working life?
What is abundantly clear is the importance of saving, in our view, at least 5% (preferably more) and investing in assets that will return at least 4%. The good news is that 4% is, generally, a very conservative assumption, in our view. We recommend a goal of saving 10% of income, and starting as soon as possible.
In an environment of some inflation, one should hope that pay will keep pace with inflation, but in our view, assuming a return of 4% above inflation is not only historically reasonable, it is conservative over a 40-year saving horizon.
Plan on living longer and working longer: The post WWII social security model is broken. When pension models became popular and government pensions were widely introduced, most countries had many more workers than retirees, and the average lifespan for those reaching retirement was much lower. According to the official social security website (www.ssa.gov), in 1930 life expectancy at birth was 58 for men and 62 for women. Only half of men who reached the age of 21 could expect to live to 65, the retirement age. For those who made it to 65 in 1940, when social security payments began, another 12.7 years for men and 14.7 years for women could be expected.
Today those numbers are almost 19 and 21 years beyond 65, according to the social security site, and the number is likely to grow. As illustrated, it takes 40 years of saving (not just 40 years of working) to seek to fund a 20-year retirement if social security is there, and of course, these are just averages. In the future, it may be possible to give people a more accurate and personal life expectancy number.
In the early years, do not be alarmed by market declines. Investing is an emotional experience, which is where advice can help. Bull and bear markets (significant rises and significant declines in price) will likely happen during your savings years. Think about it – you would probably much rather see declines in the early years, while you have less money and are adding every year or every pay period. Assuming what you are investing in goes up over time, you want to have prices at their lowest when you are buying and at their highest as you approach retirement. Emotionally, we like to see our money grow, even in the early years, but logically we should recognize that when we are “putting pennies in the jar,” lower prices are a good thing as long as we believe markets will go up over time. If we don’t believe that, then we shouldn’t be investing.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Opinions expressed are those of the James Hyre and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. The examples provided are hypothetical in nature and are presented for illustrative purposes only. They are not intended to reflect the actual performance of any particular security. Future performance cannot be guaranteed and investment yields will fluctuate with market conditions. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members.