Like most complex financial matters, the quick answer is “it depends.” That said I’ll bet it’s not exactly the 10% of your pre-tax income espoused by some dude on the radio who knows nothing of your personal situation (who in fairness is just throwing out a rule of thumb he picked up from another random on the radio who picked it up from…you see the problem here). The point is that your situation is unique and thus a rule of thumb approach doesn’t cut it. Use a rule of thumb the next time you slather icing all over your favourite cake (I call it Friday night) – not when talking financial security (or lack thereof) for 30+ years of retirement.
So what is one to do instead? To me there is only one suitable approach – having a detailed, thoughtful and personalized wealth accumulation model (plan) in place (deeper dive on specifics in a moment). This is still a broad general approach in that all models will have variation but those as described should be effective. This brings us to the next take away – the model is not an exercise in precision; it’s a “good enough” roadmap in an ever changing landscape, serving as a guide that can be updated as needed and monitored to track progress. Or how about this (I’ll get preachy for a moment) – it’s something adults look after to ensure quality of life is preserved.
So what exactly is a “detailed, thoughtful and personalized wealth accumulation model”? Well it’s either a spreadsheet you download (generally for free) and populate, an online calculator, a document created in concert with your financial planner or the output from a software package you pick up and put to use. David Trahair, a personal finance writer, offers a great freebie spreadsheet here: http://www.trahair.com/smokemirrorscourse.html. Click on the “retirement optimizer spreadsheet.” Spreadsheets and calculators are easily found with a Google search. Small words of caution – some calculators (and spreadsheets for that matter) are too simplistic making them less effective. Even still they are multitudes better than following a rule of thumb approach with no plan and no monitoring.
Depending on one’s knowledge base with personal finance, the “do-it yourself” approach may not be the best idea in this setting. If the inputs (numbers) to one’s model are not fully informed, the outputs (amount you need to save each year and accumulated savings) become unreliable. This is when using a professional is likely the best option. Many financial planners prepare retirement savings plans and charge an hourly rate. Price will vary with complexity of situation; but $1K to $2K in cost is likely. This is a lot of money but quite honestly is money well spent if you focus on the impact. Namely having a realistic plan to hit your retirement in full stride and maintain, not the mention to stress avoided that surely accompanies the “head in the sand” approach.
So when do we get serious about this plan? As long as you’ve bought into the idea of putting something aside each year, this formal approach can probably wait until you’re married, maybe even until your first or second child (I realize I’m making assumptions about one’s path in life…trying to keep it simple here people!). If you’re even further down the road in the life, then the answer is “yesterday.” The thinking behind not needed to get out ahead of this one at say, age 20, is that until you know the financial outcomes of marriage, kids, stable career etc. a detail plan is a shot in the dark and thus reliability and accuracy become issues. This obviously doesn’t preclude the keeners out there from taking advantage of the free resources out there and having on their radar sooner.
The most significant assumption (input) to the model is how much money one needs each year in retirement. This is a hot button topic and perhaps worthy of a future post. I’ll simplify and say this; it is typically calculated as a percentage of one’s annual income in the years just before retirement. In terms of the percentage, I’ve read from all the “experts” out there anywhere from 30% right up to 100%. Do some research and consider your own personal circumstances.
The key piece of information obtained from the model is how much one needs to save each year to achieve their retirement goal of X dollars annually to spend. Again the key is the personalized approach with real figures conforming to one’s unique situation – not some rule of thumb guess work. Once empowered with this information, the ongoing application and challenge is figuring out how to structure one’s affairs to stock this amount of money away each year. But hey – you’re savvy, I mean you found the blog in the first place, so you’ll figure it out.
The findings may be surprising, for good or for worse. If you’re in a good spot, maybe your retirement goal can be reached earning 4-5% on your savings each year. Perhaps it will be a few (many) points higher. Well this might be a blow in the short-term; at least you’re no longer in the dark and can start planning around it.
As a bit of an aside, two thoughts on investment selection 1) increasing savings (namely controlling costs) is a safer approach for reaching retirement goals then chasing high returns in high risk speculative investments and a related point 2) if all you need (from your plan) is 4-5% to make the retirement of your dreams happen, why take the risk of even holding high risk investments that are just as likely to lose 25% as gain 25%. Go with the safer choice that will yield the 4%-5% you need. Said another way, don’t put your family fortune (which impacts more then you) at risk by chasing money you don’t need, simply as a means to stroke your own ego.
To sum up, your finances for your last third of your life – and by extension your quality of life – is obviously serious business. Plan for success and hold yourself accountable, to a standard much higher than guess work – put a detailed, thoughtful and personalized wealth accumulation plan in place. Look for thoughts on how to navigate this plan over time at a later date.
The author, Pat Kenney, is a Chartered Professional Accountant. He has worked in public practice at a local boutique CPA firm in Mississauga for 9 years. He currently holds a senior management position.by