When you hear SAT you typically think of college entrance and not retirement. However getting into retirement and having successful and sustainable income requires scoring well on its SAT. In this case SAT stands for Savings, Allocation (target rate of return) and Time.
How much do you need to save for your retirement? That depends on many factors such as how much you have already saved, the assumed risk adjusted return and how long you save. Let’s start with how much retirement income you expect during a hopefully healthy retirement and long lifespan. What income sources do you expect to receive?
- Social Security
It’s important to know if these sources of income are adjusted for the rising prices you’ll likely experience through retirement (inflation) and If you do not have cost-of-living adjustments for this income than your savings will also have to make up for the fact that these will not be rising as you age. Ideally you will be able to take advantage of 401(k) savings vs. IRA contributions ($17,500 vs. $5000). If not, the equivalent in a non-tax advantaged account will cause you to save more.
Savings is one of the two SAT variables you can control.
This table shows the effect of savings, when holding the return and time the same.
|Rate of return||8%||8%||8%|
|Time (Years to retirement)||35||35||35|
|81% underfunded||65% underfunded||41% overfunded|
Example assumes an annual retirement income target of $50,000. These are hypothetical examples and are not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
Retirement risk tolerance (Allocation)?
Many people choose to invest and hope for the best. Another higher probability approach involves mixing your selecting investments from categories that have shown predictable patterns and putting them together in a systematic way. It does not mean you may not see ups and downs in your portfolio, it’s just that it will be a bit more predictable. For example, the S&P 500 since 1929 has returned an average of 10%.1 You could choose to plug that number in it your target rate of return for your allocation number. You might already know that you aren’t willing to take that kind of up-and-down market ride that historically was required to get that average. Let’s say that you’re more comfortable would say 5% and would add other less spicy investments to moderate. It is important to answer two questions:
- What is your natural tolerance for risk?
- What level of risk do you need based on your savings and time constraint?
Hopefully the former is greater than the latter. If not, you should work with an investment professional that is a patient coach and one that must work in your best interest. Ask your current or future prospects if they will be a fiduciary (best interest)? Would you rather take on more investment risk to save less or work longer? This table shows the effect of varying return when holding the savings and time the same.
|Time (Years to retirement)||35||35||35|
|72% underfunded||60% underfunded||36% underfunded|
The return you actually get may or may not be more or less than what you targeted. It is a variable out of your control.
Time to retirement
Savings is one of the two controllable factors in the retirement SAT Many people think that retirement means age 65. That age is when some workers received full benefits from Social Security. That age does not mean that you have enough money to maintain your lifestyle without working (financial independence). Did you know that delaying retirement until age 70 increases the Social Security payout? Would you rather work longer rather than take on more investment risk or save more?
This table shows the effect of varying times when holding the savings and return the same.
|Time (Years to retirement)||30||35||40|
|65% underfunded||36% underfunded||37% overfunded|
Tailoring your retirement SAT?
Would you rather save more than take on more risk? Would you rather work longer than take on more risk? Is your ability to save constrained by other commitments like debt and your kids’ education? We understand that there are more considerations than the one’s outlined here. The challenge with the SAT is to determine the trade-offs that work for you That’s why I recommend finding a CERTIFIED FINANCIAL PLANNERTM professional to help you tailor the calculations based on your realities.
This exercise shows why I don’t like simplistic target date investment strategies because they don’t know your savings or time horizon. They don’t even care about your tolerance for investment risk. If you want our help you can start the conversation with a financial review or a Portfolio Risk Review. As the exercise shows, time is not on your side.
Copies of the assumptions used and more expanded results can be found here.
(1) Reflects average annual total return of the S&P 500 including dividend reinvestment from 1926 through 12/31/2013. The S&P 500 is an unmanaged index which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.
(2) No strategy assures success or protects against loss. Stock investing involves risk including loss of principal.