Keep your nest egg on track
It's not easy to know whether you'll have enough to retire on, but there are some checkups to help you stay on target.
NEW YORK (Money) -- Question: I'm 40 years old, and according to an online calculator I used recently, I should now have $900,000 saved to assure a comfortable retirement. I'm guessing I have only about $100,000 (I'm afraid to look). What is the best way of making up the $800,000 gap over the next 25 years? --Jeff, Canton, Michigan
Answer: Whether it's using online tools or working with an adviser or both, I'm a big believer in people trying to a get a handle on whether they're on track toward a secure retirement.
After all, one of the more interesting findings of the Employee Benefit Research Institute's recently released 2009 Retirement Confidence Survey is that people who do a retirement needs calculation are typically better prepared for post-career life than those who don't.
Specifically, those who have done such an analysis are three times as likely as those who haven't (33% vs. 11%) to have $100,000 or more saved for retirement and six times as likely (19% vs. 3%) to have saved $250,000 or more.
Granted, that disparity probably reflects the fact that the people most apt to engage in such an exercise are also most likely to be diligent savers. But, still, I think there's value in having a goal to shoot for and monitoring your progress toward it.
That said, it's also important to keep this sort of analysis in perspective. Writing in the early 90s about quantitative investing models, Robert Merton, an economics Nobel Prize winner and one of the brains behind the failed Long-Term Capital Management hedge fund, noted that "the mathematics of the models are precise, but the models are not, being only approximations to the complex, real world." Thus, he cautioned that people should "apply the models only tentatively, assessing their limitations carefully in each application."
I think the same can be said of calculators and software for retirement planning. When you're making projections 10, 20, 30 or more years into the future about your retirement prospects, you're dealing with tons of assumptions about the economy, interest rates, investment returns, inflation, your ability to maintain a savings regimen, etc.
Clearly, that means you have to allow for a rather substantial margin of error. Which is why the best calculators and software tend to couch their results not in precise figures as in you will need $2 million or you should now have $900,000, but in probabilities: if you follow the path you're now on, you'll have an 80% chance or whatever of achieving your retirement goal.
And regardless of the answer you get, remember that it represents a snapshot of where you may end up if all the assumptions pan out and if you continue on your current path - i.e., save at the same rate, follow the same investing strategy and retire at the age you now plan. In the real world, of course, your life isn't a snap shot. It's a moving picture. And you have the ability to change the path you're on by changing the amount you save, the way you invest, when you plan to retire and how you live in retirement.
Which is why I wouldn't get too fixated on any single number, or too discouraged if it shows you're well behind in your planning because there's always something you can do to improve your situation. And I wouldn't get irrationally exuberant, so to speak, if it shows you're so far ahead that you probably have nothing to worry about. (I'm sure some people likely felt before the market fell apart in 2008).
So how does all this apply to you and what you should be doing over the next 25 years?
Well, for starters I wouldn't assume you actually need $900,000 today to have a reasonable shot at a comfortable retirement. A required nest egg that large 40 years from retirement implies a very, very large current and future retirement income. I'm not saying it's impossible, but before you do anything, at the very least you'll want to re-run the numbers.
I don't know which calculator you've been using, but I'd try it again on one or two that use Monte Carlo simulations that couch your success as the odds or probability of reaching your goal. Both the T. Rowe Price Retirement Income Calculator and the Fidelity myPlan Retirement Quick Check tool use this approach.
The nice thing about calculators like these is that they don't just tell you you're $800,000 short or whatever. They also suggest various ways for you to improve your prospects.
So, for example, if, after entering all your information, you find that your odds of a secure retirement are uncomfortably low, you'll be able to see how the odds change by boosting the percentage of pay you contribute or changing how you invest or postponing retirement, or doing all these things and more.
Of course, there's always the possibility that the magnitude of change required - say, the new level of savings needed - may prove undoable. I mean, you've got to live your life. You can't save all your income for retirement.
If that's the case, you do what you can, and realize that you may also be able to make other adjustments later on, such as working in retirement or tapping the equity in your home via a reverse mortgage for more income after you've retired.
Finally, remember what I said about life being a movie, not a shapshot. Things change. The economy, the markets, your ability to save. So you'll want to re-do this analysis every year or so. By monitoring your progress and making gradual adjustments as necessary, you'll be much more likely to stay on track and avoid unpleasant surprises near retirement day.
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