Terrible Advice You Should Ignore

What would you do if someone said you could eat more candy and work out less, and you'd still be healthy? If you're like me, you'd be excited -- but you'd probably think it was too good to be true.

Those were my thoughts when I read about the estimates of Harvard economist David Laibson. According to Laibson, about 10 percent of Americans actually save too much money for retirement.

Yes, dear reader, just when you thought you had investing and planning under control, it turns out you might have to reconsider. Though Laibson might not say it, these estimates imply that if you're saving too much for retirement, you could be spending more along the way.

That's where the alarm bells come in for me. I liken that to saying, "Sure, stay home from the gym and eat a couple of cookies." Knowing my own sense of discipline, I'd quickly be a couch potato with a heart condition, so I'd hate to see what that kind of thinking would do to my finances.

So where's he coming from?
I don't make a habit of disagreeing with Harvard economists, but here's the deal with this one. Laibson's 10% supersavers generally work for companies that offer solid retirement contribution plans. When the savings from those plans get added to Social Security payments, pension benefits, and housing wealth, it ends being more dough than these folks need once they retire.

Of course, the magic behind this line of thinking is that it depends on guaranteed Social Security payments and "relatively paternalistic" pension plans. These may be fine assumptions if you're retired now, or if you're retiring soon, but for anyone who began working in the last 10 years, or who will start working at any point in the future, these are dubious propositions.

After all, the Social Security Administration itself stated that it will only be able to pay out 78% of scheduled benefits by 2041, meaning that average retiree benefits at that point will be worth less than what a minimum-wage job pays! And with pensions being cut and frozen left and right, those can't always be relied upon either. Retirement is when you're supposed to spend time with your grandkids, travel the world, and play golf. It's tough to do that on minimum-wage money.

But that's not all!
But the broader danger here is that learning about the 10% of people who supposedly save too much could lead you to underestimate how difficult it is to save for retirement in the first place. Traditionally, retirement savings have rested on a three-legged stool made up of Social Security benefits, pension payments, and personal savings. With Social Security's problems, and the phasing out of pensions, Americans may be forced to shoulder most of the burden on their own.

What does that mean in dollar terms? The Fool generally suggests that you should plan to withdraw 4% of your nest egg every year in retirement. This could mean you might need around $1 million or more in personal savings in order to enjoy your pre-retirement lifestyle.

The best (legal) way I can think of for coming up with $1 million is by building a winning portfolio of stocks. And any portfolio needs to start with some solid dividend payers. By collecting and reinvesting dividends over the long term, you give yourself the best chance possible for outsized returns.

Take an investment in Johnson & Johnson (NYSE: JNJ  ) , for example. If you'd bought 100 shares of the pharmaceutical giant in 1980, and invested all of your dividends, you'd be sitting on a 7,000% return and more than $570,000 today! That's not too shabby.

If you're looking for more companies like Johnson & Johnson, here are a few candidates. All are solid, sustainable dividend payers with market-leading positions.

Stock

Industry

Market Cap

Dividend Yield

Procter & Gamble (NYSE: PG  )

Household Products

$184 billion

2.8%

Philip Morris International (NYSE: PM  )

Tobacco

$92 billion

4.7%

ExxonMobil (NYSE: XOM  )

Oil, Gas and Consumable Fuels

$309 billion

2.8%

Intel (Nasdaq: INTC  )

Semiconductors

$115 billion

3.1%

Pfizer (NYSE: PFE  )

Pharmaceuticals

$143 billion

4.1%

Dow Chemical (NYSE: DOW  )

Chemicals

$33 billion

2.1%

Source: Yahoo! Finance.

Another great place to find dividend stocks is the Fool's Income Investor advisory service. Dividend hound James Early has compiled his list of the 50 best dividend stocks out there, including six he thinks should anchor every portfolio. In addition to Johnson & Johnson, he's also a big believer in utility giant Southern Co. To find out the rest of his Buy First stocks, you can take a 30-day free trial at no risk. Simply click here.

This article was originally published Jan. 19, 2010. It has been updated.

Matt Trogdon owns shares of Philip Morris International and Southern Company. Philip Morris International is a Global Gains recommendation. Johnson & Johnson, Southern Company, and Procter & Gamble are Income Investor recommendations. Pfizer and Intel are Inside Value recommendations. Motley Fool Options recommended buying calls on Intel. The Fool owns shares of Procter & Gamble. The Motley Fool has a disclosure policy.


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  • Report this Comment On March 02, 2010, at 3:17 PM, kurtdabear wrote:

    I seldom find myself in agreement with Ivy League economists, but in this case, Prof. Laibson is on target.

    One oft-repeated mantra holds that people will need at least 85% of pre-retirement income to live comfortably in retirement. But that figure has primarily been promoted by the mutual fund industry. Gee, I wonder why?

    If a person has been saving, say, 10% of his income toward retirement via a 401K or IRA and protecting his stream of income with life insurance, then the day he retires, he no longer needs to pay the 10% retirement contribution or the life insurance premiums, and he also stops paying roughly 9% in Social Security and Medicare taxes. That means he's already down to only needing about 80% of his pre-retirement income before we even begin subtracting job-related costs such as commuting, dry-cleaning, lunches, etc.

    So if you need less and make less, you also fall into a lower tax bracket, so what you do have goes further.

    Obviously there's nothing wrong with having more if you can comfortably afford to save and invest more, but people shouldn't fearfully mortgage their pre-retirement lives shooting for a target that's set by an industry that profits from such self-serving advice.

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