What does “retirement readiness” actually mean?How do you define retirement readiness?
A recent Confidence Survey (RCS) showed that two-thirds of working Americans reported that they are confident or somewhat confident they have saved money for retirement. More than half of those workers have less than $25,000 in total savings and investments (excluding home and defined benefit pensions).
The most telling statistic of all in the RCS survey is that only 46 percent of those surveyed had completed a retirement needs calculation! That means only slightly more than half of persons contributing to retirement plans have any idea how much they need to save. Is it any wonder that we have so little saved?
First things first
Your retirement goal determines your retirement savings needs. In other words, you should begin with the end in mind. At what age do you want to retire. What kind of lifestyle do you want?. Where do you want to live? Will you ultimately retire or work part-time to stay active? What type of income (in today’s dollars) would make you feel secure?
You will notice that the income needs are last on the list. What you value, those things that are most important to you in life, are critical to your having the discipline to stick with a savings plan. If the goal is just to accumulate an amount of money, it will be easy to get off track. There will always be other, more critical things on which to spend money. However, if the things you value are foundational to your retirement goal, it will be much easier to stick with your plan.
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What is in the toolbox?
Any company retirement plan comes with resources to help you the amount you need to save. If you do not take advantage of those resources, it will be hard to reach your stated retirement goal. Talk with your plan representative to see what options they offer. Retirement calculators range from the very simple to the very complex.
Simple calculators ask you to provide necessary information (including current age, desired retirement age, ongoing total savings, desired income, the rate of return on investments). Then the program calculates an estimate of how much you will accumulate by the desired retirement age. These calculators often assume a fixed rate of return and savings for the duration until retirement. Return estimates that are too high or low produce lump sums at retirement that are unrealistically high or low.
Many advisors recommend calculators that use return assumptions based on market data for the asset classes available in the plan. Rather than come up with a lump sum number, the better calculators express retirement readiness as a probability of success. The calculators run hundreds of sample accumulation scenarios to come up with this measurement. Most of these tools recommend that to achieve success; the results should range from 75 percent to 90 percent probability of success. Retirement planning is not an exact science. Calculators that present success as a probability provides a much more realistic picture of success.
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A word about risk
Once you have determined the amount you need to save, you must then decide how to invest those savings. If you use the right retirement planning tool based on the probability of success, you will receive a report with a recommended portfolio allocation. That allocation defines your need to take the risk. That, in turn, must align with your willingness and ability to manage that level of risk. If it does not, your plan will likely fail. Let me explain.
In investing, risk and expected return correlate. The more money you have in stocks, the higher your expected return. With the higher expected return comes a higher risk of short-term loss. Let’s assume the plan’s recommended allocation means you may be subject to a 30 percent drop in portfolio value. If seeing this drop causes you to panic and sell your stock funds, you are taking more risk than you should. To be successful, you must be able to stay invested in good and bad markets.
I call this passing the stomach test. If the thought of a 30 percent portfolio drop causes your stomach to become queasy, you are taking too much risk.
Each person likely has a different definition of retirement readiness. There are many ways to get there. Design your plan around those things in life that are most important to you. Use the resources offered by your employer through the company retirement plan to determine how much to set aside. If you find those tools are not adequate for you, seek the help of a financial advisor.