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Last week we looked at how the 4% rule for retirement savings was no longer useful, and has left many retirees without enough money to enjoy their golden years.
But there's another reason retirement savings aren't delivering enough for us to live on after we stop working.
It's not just that we aren't doing the right calculations; it's also that we aren't always using the right tools.
The Retirement Savings Landscape Has Changed
When our parents worked decades ago, they were "lifers." If you spent twenty-plus years at the same place of employment, then you had a pension waiting for you to take care of expenses in the twilight years.
Since the1980s, there's been a shift in what's available for retirement plans. Corporations saw that pension plans were too costly and a more cost effective way to provide retirement savings was to sponsor plans that placed the saving onus on the employee.
That's when a lot of people got into trouble.
I used to facilitate retirement enrollment meetings and benefit fairs where the problems were glaringly evident. Most 401(k) participants did not know the basic concepts of investing, but had their entire financial future depending on these investments.
Their only experience with 401(k)s was an enrollment meeting where a representative from their 401(k) provider there to sign you up. They were shown pie charts that explained how to invest in the new plan.
And what did the pie charts say? Invest depending upon age. If you were young you needed to be aggressive. Just put it all in equities and any losses would be made up by the time you retire.
In fact, many pie charts showed that if you had more than 11 years until retirement, you should keep being aggressive. When you finally get in a certain window, then re-allocate.
But there's a problem. Those pie charts couldn't answer questions.
Back in 2007 when people were losing money in their retirement plans, pie charts couldn't console them and offer different diversification strategies. What a pie chart couldn't do is tell you that the financial landscape was changing.
It's just not in a pie chart's nature to be flexible.
That's why about one-third of Americans reach retirement age with Social Security as their only source of income. For those categorized as low-income, it jumps up to about three-fourths of that population.
But there are plenty of tools available to avoid this passive retirement savings plan.
How to Improve Retirement Savings
The problem with pie charts was the strategy. It dealt with the destination and not the journey. Many processes and "rules of thumb" follow this same fallacy.
But what most investors and savers want to know now is "Am I on track?"
There are all types of devices and programs that give you a "number" of what you need to retire "comfortably". However, how do I get there? Where should I be at the age of 40 or 50?
Well here is a new "rule of thumb" that does just that.
Fidelity Investments last September released a new roadmap that outlined simple savings guidelines to help you keep on track to reach retirement goals.
Fidelity bases the proposed retirement needs on your current income. But it's just not income alone. This rule acknowledges that every investor is different and unique, but it has to make some generalizations.
What they came up with is that the typical investor could replace 85% of their working income by saving eight times that salary.
They break it down like this:
- By 30, you'll have half of your current salary in savings.
- By 35, you'll have your full salary.
- By 40, twice your salary.
- By 50, four times your salary.
- By 60, six times.
- By 67, you should reach eight times your salary.
According to Fidelity, these are the assumptions that were made:
- Fidelity's retirement guideline is based on a worker using his workplace retirement plan starting at the age of 25.
- The plan assumes that this same worker will work and save continuously until age 67.
- This person will live to the age of 92.
- The ending retirement pool would include workplace retirement plans, IRAs and all other savings.
- The investor will make non-stop 6% of salary contributions each year to their workplace plan.
- The contribution will increase 1% per year until he gets to 12% (this also assumes an ongoing 3% annual employer contribution).
- Fidelity Investments' models came up with a lifetime average annual portfolio return rate of 5%.
- Social Security payments are used to figure out the replacement income ratio of 85%.
- The investor's salary increases by an average of 1.5% every year over general inflation.
- It assumes no breaks in employment or savings
Keep in mind that the "eight times your ending salary" may not be right for everyone. Each person, as stated before, is different. You have to think about future inflation, life expectancy and possible health care costs that may be unique to you and your family.
But at least this approach gives you a blueprint to play with.
Now that you have your directions to retirement security, you now need to decide your choice of vehicle or vehicles to get there.
We'll have more coverage in coming weeks on how to handle your retirement savings. Stay tuned.
For a closer look at the sad state of U.S. retirement savings, check out The Scariest Facts about America's Retirement Crisis.