Thursday, April 26, 2007

Goals for Retirement Saving and Why They Don't Always Matter

It's April, and millions of high school seniors across the land are obsessing excessively over where to go to college. The under-recognized truth is it matters a whole lot less than they (and perhaps some parents) think. If they choose the wrong college at first, they have plenty of time and opportunity to transfer to another school. And, regardless of where they go to college, their chances for success and happiness will depend first and foremost on them as individuals. Their choice of colleges may, more than anything else, dictate which institution will be dunning them for contributions when they are successful adults.

The same could be said about goals for retirement savings. Too many people (and their financial planners) obsess excessively over this question. Clever calculators are provided on numerous websites that purport to tell you, down to the penny, how much you need to save for retirement if you want to avoid dog food in your diet. The figures generated by these calculators are intimidating. People making $70,000 or $80,000 a year are told that they need to save $1 million (and more to keep up with inflation). People who haven't started saving for retirement at age 50 or older are told they need to put aside 30% or 40% of their incomes. Not uncommonly, many people are so discouraged by these numbers that they don't bother to save at all. That's a mistake, but people faced with seemingly impossible goals often don't try because failure appears inevitable.

A simpler approach is to target a particular percentage of your income for retirement savings. Instead of trying to figure out how you could be a millionaire by age 62, concentrate on saving, for example, 10% or 15% of your income. Don't worry about how many dollars you need 30 years in the future. Just stash away your target percentage each and every year. If you establish a reasonably high target level (like 15%), which is invested in well-diversified investments, you will probably, after 30 or more years, accumulate enough money for a decent standard of living that's not far from what you had during your working years. The higher the target percentage, the greater your ability to maintain your standard of living in retirement.

So, a simple rule of thumb for a good retirement is to put aside 15% to 20% of your income. That's a lot. By using the percentage of income method, however, you won't need to muck around with a lot of calculations. You'll save one step at a time, and that's easier than trying to project 40 years into the future.

All this assumes that you are steadily employed for 30 or 40 years and can afford to put away a significant portion of your income. Life for most people is more complex. Unemployment, time off to raise kids, aged parents who need support, kids headed for college, illness or injury, divorce and a host of other problems disrupt one's retirement savings plan. You may not be able to save a fixed dollar amount or a fixed percentage of your income. In those situations, forget about your targets and simply put away whatever you can. Don't abandon the process of saving. Even a little bit invested now can add up to a lot later (remember what we've said before: if you love compounding, compounding will love you). Even if life sends a tsunami or two your way, do your best to save whatever you can. Whatever it is will be better than nothing, and you can declare victory when you retire.

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