Retirement: The 2-Sided Equation

Having been a financial advisor for over 20 years now, I’ve heard the same questions asked many times over.  Some are valid while others can be perplexing.  Some of my bewilderment stems from our American way of life which, at times, has a way of distorting what is truly important.  One of the most disconcerting questions I run across is, “Do you think I’ve saved enough money for retirement?”  This typically comes after they have shared their age and investment balances with me.  It is a question that they think should be easy for me to answer based on my years of experience dealing with clients and running retirement projections for them.  Unfortunately, it is not.    

Remember in high school when your teacher would tease you with all kinds of data points in an exam question and then ask a question totally unrelated to the data points provided?  What was the correct answer back then is the same answer to this commonly asked retirement question, “I don’t know. You haven’t provided me with enough information.”

Retirement is a 2-sided equation.  Savings balances are important, but retirement readiness is just as much a function of what you plan to spend.  American society, in all of its infinite wisdom, has a way of getting us to focus only on the savings side.  Yes, this side of the retirement equation is incredibly important and necessary.  However, the emphasis we’ve placed on having saved enough should be matched with an equal emphasis on understanding how much we are currently spending.

You may recall the long running ING ads that asked, “What is your number?”  These commercials had people walking around in public carrying their orange number with them as if to say, “when my investments hit this number, I am good to retire.”  As a financial advisor, I truly wish it was that easy.  Unfortunately, it is not.  A person needs to be as concerned with their living expense needs as they are with their investment account balances.  When a person has a good grasp on both sides of their retirement equation, it is then and only then, that they should feel confident in pulling the trigger on their retirement. 

But, hey, we live in America.  ING could have run corresponding commercials that talked about the importance of understanding and tracking your budget, but this topic is boring and no one would have remembered these commercials.  No one likes to track how much they are spending on an annual basis.  No one wants to know exactly how much they squander on meaningless purchases on a monthly basis.  It is far more fun to talk about how much money we have saved.  We live in a society built on not only trying to keep up with the Jones, but trying to one up them.  If my neighbors say they are millionaires, then I need to be a multi-millionaire.  While amassing wealth may create envy among your neighbors and garner attention from marketers trying to win your business (especially those in my industry), your net worth, on a stand-alone basis, will not be the sole determinant of your retirement success. 

I have met and worked with countless 65-year old couples already in or nearing retirement.  Some of these couples have $400,000 saved up, others may have $1 Million saved up, still others may have in excess of $3 Million saved up.  No matter what their level of savings, it is not appropriate to make a judgement on the probability of their retirement success until we, as their advisor, have a firm understanding of their spending habits and living expense needs.  Do they have a higher percentage of fixed versus discretionary costs?  Are they too proud to ever drop their private club membership?  Will they be flexible if times were to get tough?  These are not fun questions to ask but they need to be addressed as part of one’s retirement equation. 

Despite working in an industry that caters to those with bigger versus smaller investment balances, I feel we are unique here at Modern Dollar as we do not judge a person by their investment account balances alone.   In fact, we have found very little correlation between money saved up and retirement success in general.   Why is this?  How could this possibly be?  Our society places so much emphasis on becoming a millionaire and trying to get your account values as high as possible such that you can safely and securely retire.  Someone with $3MM saved up surely has a better chance of a successful retirement than someone who only has $400,000 saved up!  Well, I’m here to tell you that this is not always the case. 

It is not always the case because, again, retirement is a 2-sided equation.  Yes, it is great to have more money versus less money saved up, but it then becomes a function of how much money you need to live off of.  When you have both sides of your equation figured out you can compute your withdrawal rate.    If your anticipated withdrawal rate is 4% or less, you have a good understanding of your living expense need and your lifestyle is flexible, then we can feel pretty good about your chances of a successful retirement.  If you don’t have a good handle on your living expense need and your anticipated withdrawal rate is above 4% then we need to take a good, hard look at whether you should be saving more, spending less or working longer.

 If we lived in a society that placed just as much emphasis on learning how to budget and to live within our means then there is on promoting bigger investment account balances, we would all be better off in retirement.  The rhetoric only focuses on the one side of the equation.  It is an important, sexy side, but I would argue that the other side of the equation, understanding what you need to live off of, is equally, if not more important.   

So the next time someone asks you ‘what your number is,’ remember to respond, ‘it depends.’  Your retirement number is a function of a two-sided equation.  If you know what your living expense need is, then you will know ‘what your number is.