How much savings is enough for retirement?

There is a number hanging over our heads. It is a bigger number than most folks realize. It’s the dollar amount of investment assets necessary to afford the sort of retirement lifestyle we expect.

At some point in the not-so-distant future, our incomes will stop and we will begin to live on our savings, plus a bit of Social Security income. Our savings include pension benefits, funds in 401(k) plans and IRAs, and other investment assets. The sum total value of these assets will produce some rate of return. We expect to withdraw our living expenses from these assets and have them never deplete while we are alive.

Forget the family home as an investment asset. We will need a place to live, one way or another. Unless we plan to abandon the coastal San Diego lifestyle completely and move to, say, Indiana, a nice place to live will continue to cost about what it costs now. I suppose one could sell the family homestead and move to an apartment, but that’s not really the retirement lifestyle any of us have in mind.

So how much is enough? On the fateful day that the paychecks stop, how much need we have accumulated? Naturally, it depends on three factors: How much do we want to withdraw every year, after tax? How long will we withdraw it? What will be our investment return? It’s not possible to present every possibility in this short column, but let me give you some things to think about.

Let’s say I retire at age 60. I will expect to need my money to last me at least until I’m 90, just in case I beat the odds and live a bit longer than the bell curve says I will. Let’s say I will need $6,000 per month, in addition to my meager Social Security benefits. The amount I need in my various savings accounts at age 60 depends on my assumptions about investment return. This is where it gets a bit tricky. You will get as many answers to that question as there are investment professionals.

If someone is trying to sell you a variable annuity or other high-commission investment product, they will encourage you to expect very high rates of return. They will produce historic data to support this expectation. But, the data will give you whatever answer you want, as long as you are picky about the time periods you use. If you assume the period 1932 to 2000, you earned an annual rate of 8.81 percent on large-cap stocks. If you instead assume the period 1929 to 2003, you earned only 4.64 percent per year.

If you assume the higher return, you need save only $1.7 million. If you assume the lower return, you need to save $2.8 million, a whopping $1.1 million more!

The assumption about the rate of return is a critically important driver of our savings decisions. As you might guess, my advice is to err on the conservative side. Far too many financial and retirement plans are being laid on a foundation of double-digit returns. The actual data from the real world show that such a result would be an historic anomaly.

Rental yields on income property are under 7 percent right now. Bonds yield less than 5 percent. Earnings yields on stocks are under 5 percent. Dividend yields are about 2 percent. Domestic and worldwide economic growth is rolling forward at about 5 percent. How do we add these numbers together and get 10+ percent returns to passive investors? Only if we are irrationally exuberant. The problem we humans have is that we latch our brains onto times when returns were high, and forget about the corrections along the way. The only way the stock market pays 15 percent for a while is if it also goes through a period paying nothing. The stock market is hot once again, yet most people forget that the S&P 500 is still barely back to where it was seven years ago, and the NASDAQ is a long, long way from recovering to its earlier highs.

As you sit down to punch up the figures on your future retirement needs, I encourage you to keep conservative return assumptions in your calculations. If you are wrong, then you will have extra money to do good works. But, not running out of money is your most important retirement planning objective.