How and How Much to Save For Retirement

This is the next item in the list provided in 10 Dirt Simple Rules of Money Management, where I provided 10 rules to follow to maintain a healthy and happy financial life.   (Note, you can find all of the posts in this series by choosing Dirt Simple from the category list in the right sidebar.) Today we cover the fifth rule:

4.  Put away 15% of your paycheck for retirement as the first thing you do.  Automate all you can.

Retirement.  The word evokes images of sitting in a rocking chair, travelling the world, or sitting on the beach.  For many it is extended visits for time with grandchildren, many of whom are in other states, or perhaps getting time to work on some projects you’ve been putting off.  Few people have images of sitting around, stressing over how to get the next meal or pay for important prescriptions, and yet that is what retirement holds for many who don’t start to save and invest until it is too late.

Saving enough for retirement is a huge hurdle.  If you’re retiring this year, you’d want to have more than a million dollars saved up – closer to $2M would be better.  If you are twenty years old and reading this, you’ll probably need around $4M – $6M saved to afford a comfortable and secure retirement.  This may seem an impossible amount, but it really doesn’t take a great sacrifice if you do a little at a time.  If you wait until you can see retirement around the corner, it is next to impossible.

People long for the days of pensions since they saw it as a much more secure and guaranteed source of income in retirement.  The truth is, you’ll do a lot better in a modern 401k plan, or simply saving and investing for retirement on your own, than you will with a pension.   The reason is that pensions are invested in a manner suitable mainly for people who are going to retire in five or ten years all of the time, instead of investing for long term growth while people are young and then becoming more conservative as they near retirement.  This is because pension plan managers need to be sure that the money will be there for people in the company who will retire soon.  This means that your return from your pension plan will be a lot less than it would have been if you had invested it properly yourself.   Someone who is in her twenties, thirties, or forties should be heavily in stocks and growth assets rather than perhaps half in income and half in growth as are pension plans.  Companies also set payouts low relative to the returns they expect from their investments to build in another margin of safety.  Of course, many pension plans are still underfunded since companies tend to fund the minimum required by regulators and then save their money for other things.  The pension plan investments are also the first thing cut when economic times get tough since they are competing with keeping the lights on and researching for the next products.

Social Security is a form of national pension plan, but it is on even shakier footing than corporate pension plans and the rate of return is absolutely dismal (it may be positive, but it is about on par with a savings account).  The trustees for Social Security (and Medicare) have reported to Congress numerous times that the program will run out of money in a few years and serious decisions will then need to be made.  Unlike a corporate pension plan where at least your contributions are invested, Social Security is a system where everything going in that is not paid out immediately to current retirees is spent on other things, just like other taxes.  Like a Ponzi scheme, this worked fine as long as there were many more people working than drawing benefits, but now that the ratio of payees to payers is changing, something will need to be done over the next ten to twenty years – even sooner perhaps depending on how things go.  This means payouts will be cut and perhaps taxes will be raised.

So why is it that pension plans are seen as safe and secure, and 401ks are seen as risky?  And why are many people not as well off with a 401k as with a pension?  The reason is our own behavior.  With a pension plan, you’re forced to contribute from every paycheck and you cannot take the money out before retirement no matter what.  (Note, even if the company pays for the pension, you’re really the one contributing since they could pay you more if they didn’t need to fund the pension plan.  The money that goes into that pension plan is created through your labor, not some other source of corporate funds that magically appear.) This allows the money time to compound and grow.  Even in retirement, unless the plan offers a lump sum payout, you are forced to leave the money there and take just a small amount out at a time with a pension plan.

With a 401k plan, conversely, people treat it like a giant piggy bank.  They don’t contribute enough, perhaps just putting in whatever the company will match, if that.  They then take loans out against their investments, which effectively become early withdrawals if not paid back soon after leaving a company or being laid off.  Finally, when they get into their forties or fifties and they finally start to see some investment income coming in as their 401k starts to build into that multi-million dollar account they’ll need in retirement, they get the whim to start a business, pay for a wedding or college, or simply pay off debt and break into that piggy bank despite the huge tax penalties.  They then approach retirement and bad-mouth 401k plans.

If you want to have a safe retirement, you need to treat your 401k just as you would a company pension plan.  This means you need to contribute enough and you need to not touch it for any reason until you are retired.  Even then, you need to withdraw the money out responsibly to preserve the balance and let it grow to cover the higher expenses you’ll face later in retirement as inflation and medical bills take their toll.  With a 401k plan you need to:

1.  Contribute at least 10% of your paycheck every month.  15% would be even better.  If it won’t all fit in a 401k, invest in an IRA and then taxable accounts as well.

2.  Make sure you capture all of the company match.  Unless you have a crazy-generous company, investing 10% will do this, but even if you decide not to invest the full 10%, make sure you’re at least investing enough to get everything your company is willing to give.

3.  Automate the investments, right from the start.  As soon as you get home with the paperwork from the HR office, fill out the form for the 401k and setup for your 10-15% contribution.  If you do this right away when you start, you’ll never miss the money.   It is much more difficult to cut lifestyle later.

4.  Select the lowest cost funds you can find in different sectors of the market.  Go with index funds and other unmanaged funds where possible since they will have the lowest costs.  Splitting money between large caps, small caps, and International is a good way to go.  You can also split between growth and value funds.  When you’re young, you have no reason for any significant amount of income investments.

Got an investing question?  Write to me at or leave a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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