The standard retirement advice is save as much as you can, right from the start. But there is another aspect that you must look into – your lifestyle. Here’s a brief run down on both these aspects.
Michael Kitces is a partner and the director of wealth management for Pinnacle Advisory Group, co-founder of the XY Planning Network, and publisher of Nerd's Eye View.
Here he shares his knowledge with Karen Wallace of Morningstar. Below is an extract from that conversation.
Always look to increase the quantum of your savings.
We talk of compounding, but there is an unfortunate reality which is the mathematics of it. If you had a couple of thousand rupees and you earn an extra 1% of returns, it may sound great, but the extra 1% of return on a few thousand rupees won’t get you far. It doesn't have a big impact because the account balance just isn't as big yet. But that extra 1% return on Rs 10 lakh is much more impressive.
As you get closer and closer to retirement, that equation starts to flip around. Even a thousand or so every month towards getting a big nest egg doesn't really actually move the needle very much anymore. But if you've got crores in savings already, a 1% change in your returns could be a year or two worth of savings, all at once.
Whether you save and create the savings habit is overwhelmingly, dominatingly the biggest factor that drives the outcome.
There's this kind of balancing shift; it's mostly about whether you save at the beginning but how you invest starts to really, really matter by the end.
Those that allow their lifestyle to creep higher over time, means that they are saving a little bit less and because their spending is moving up as their income moves up. And, they now need more in order to retire because the lifestyle has gotten more expensive. This means they've got further to go on this journey.
You say, I'm making more money. I'm going to upgrade a little. I'm going to get a nicer car. The expenses start creeping up. Once it becomes a part of our lifestyle, it's hard to go backward. I used to mow the lawn, but now I got a little more money. So, I'm going to pay someone to mow my lawn. Once I pay someone to mow my lawn, I rarely go back and mow lawn again. We do it with cars. We do it with houses. We do it with a lot of kind of lifestyle maintenance-oriented things.
When you save, take into account the cost of lifestyle.
We routinely see situations where people who are saving are further from retirement in their late 30s and early 40s than they were on day one. Because their lifestyle increased at a much faster rate than their income and savings.
All those little items individually may not really be budget breakers. But you start adding here and there regularly and suddenly the cost your lifestyle is much higher than it was.
Consequently, the money you need to retire now is much more than it was because you got to replace this much heavier lifestyle that you sort of unwillingly adopted or crept into.
Higher savings increases retirement preparedness and reduces retirement need.
Kitces explains this very clearly in an article.
Joe and Sally both make $65,000/year at age 35, take home about $50,000 after taxes, and want to start saving for retirement now. Each of their incomes grow at 3% per annum.
If Joe starts saving 15% of his income, then by age 65, he can save over $1.25 million.
Sally saves 25% of her income; by age 65 her account balance is up to nearly $2.1 million. In fact, she had already reached Joe’s retirement account balance of $1.25 million by the time she was just 60!
But the key distinction is that because Sally is saving more, she’s living on less, which means she doesn’t need as much as Joe to retire in the first place (at least to maintain that same lifestyle). Given that Sally is living on only $37,500/year instead of $42,500, she could have actually retired by age 54 instead – because her retirement savings need never climbed as high as Joe’s in the first place!
In other words, the key change that happened when Sally decided to save more is that she both added more to the account for future growth, and reduced her retirement savings need in the first place! Which means it not only takes her fewer takes to achieve the same amount of savings, but she can retire even earlier because she doesn’t need as much in the first place!
The takeaway:
Save aggressively.
The more aggressively you save, the less you spend since there is only so much money that comes in.
The more aggressively you save, the less you spend, the less goes in upgrading your lifestyle. There is a double-edged impact when you save more.
The people who are the best at the savings also are the ones that need the least to retire.
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