When you hear SAT you typically think of college entrance and not retirement. But there’s an SAT score for retirement, too: Savings, Allocation and Time. Here’s how you can use these three criteria (your SAT score) to see if you’re on track to retire comfortably.
Saving: are you saving enough?
How much do you need to save for retirement? Or, in other words: what’s your number? How big of a nest egg do you need? That depends on how much you have saved so far, the expected return on your retirement investments, and how long you plan to save for.
Let’s start by looking at how much income you think you’ll need in retirement, as well as your sources of income. Which of the following will you be counting on?
- 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). If you don’t have cost-of-living adjustments, your savings will have to make up for that fact.
When it comes to the amount of money you save each year, save in a tax-advantaged account. Ideally, you want to take advantage of an employer-sponsored plan like a 401(k). Not only is the yearly contribution limit significantly higher than an IRA, these plans often come with an employee match.
Savings is one of the two SAT variables you can control. And how much you save can make a big difference.
Say you’re hoping to have an annual income of $50,000 in retirement. This table shows how the amount you save now can have a bit impact later on. To show the effect of savings, I’ve left the expected return and timeframe the same.
|Rate of return||8%||8%||8%|
|Time (Years to retirement)||35||35||35|
|81% underfunded||65% underfunded||41% overfunded|
These are hypothetical examples and are not representative of any specific situation.
Allocation: does it match your risk tolerance?
Next, let’s think about the rate of return on your investments. You can never predict what your investments will return, but allocation can help you come close. Research shows combining investments from different asset classes (like stocks and bonds) helps generate more predictable returns. You’ll still see ups and downs in your portfolio, but they’ll a bit more predictable. For example, since its founding in 1926, the S&P 500 returns about 10 percent on average. You could choose to plug that number in it your target rate of return for your allocation number.
But let’s say you aren’t willing to ride out the ups-and-downs that tend to be associated with the stock market. You may be more comfortable with a 5% average annual return if it meant less volatility. So you might add other, less spicy investments to your allocation, like U.S. Treasuries.
This table shows how different rates of return, which you can target based on your allocation, affect your retirement goals when other variables are held constant. Again, we’re assuming the goal is $50,000 in annual income in retirement.
|Time (Years to retirement)||35||35||35|
|72% underfunded||60% underfunded||36% underfunded|
Remember: 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.
It is important to answer two questions:
- What is your natural tolerance for risk?
- What level of risk do you need to reach your goal?
Hopefully you don’t need to take on more risk than you’re comfortable with. If you do, work with an investment professional that is both a patient coach and working in your best interest. (Make sure he or she is a fiduciary. At Envision Wealth, the firm always acts as a fiduciary for you.)
Time: how much do you have?
Many people think that retirement means age 65. In reality, that’s just the age when you can start receiving full Social Security benefits. It’s not necessarily the age you can expect to have enough money to retire. And increasingly people are finding that they need to work longer, sometimes by quite a bit. And, if you are able to work longer and delay collecting Social Security, your Social Security payout actually increases. If you can’t increase your savings, and you’d rather not take on more risk with your investments, you may be able to change your timeframe by planning to work longer.
This table shows how increasing your timeframe can change how your retirement is funded, assuming a $50,000 a year income goal.
|Time (Years to retirement)||30||35||40|
|65% underfunded||36% underfunded||37% overfunded|
Tailoring your retirement SAT?
How you balance your SAT score can impact how prepared you are for retirement. While it’s great to score well in all three areas, you may be able to compensate for one by improving your performance in the other. (Think of it as improving your verbal score to offset a lower math score.) A financial planner can help you balance these different considerations and figure out which trade-offs make the most sense for you. We understand that your financial life consists of more than just planning for retirement.
Read more about the assumptions we used here.