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Throughout September, the Motley Fool has followed its mission to help you invest better by reaching out to millions of readers to help them gain more investing knowledge and achieve financial freedom. Assuring yourself a comfortable retirement is one of the most important ways you can get your finances in order.
One of the keys to applying your investing knowledge toward solving the problem of how to save for retirement is matching up your expectations of your retirement lifestyle with the money resources you're likely to have when you retire. A recent report from Fidelity Investments sheds some light on that all-important question, but it also raises some questions about whether you might be better off following your own investment plan under certain circumstances.
How to retire rich
It's pretty much impossible to come up with a surefire magic dollar figure that would guarantee a prosperous retirement under every circumstance. With so many variables to consider, including investment returns, costs of living, and the uncertainties of your health and other unpredictable expenses, most people would need to save up far more than they'd be able to in order to eliminate every speck of doubt about whether they'll have enough money to last the rest of their retired lives.
In an effort to make retirement saving easier, though, Fidelity came up with a list of guidelines for investors to follow. The advice takes a few different forms:
- To replace 85% of your income from before retiring, you'll need to have about eight times your salary saved in your retirement nest egg.
- If you expect to retire at age 67, then you should have savings equal to your salary by age 35, three times your salary at 45, and five times your salary at 55.
- To get there, you need to save between 6% and 12% of your salary in a 401(k) plan that pays you a 3% match. In addition, you need to earn a 5.5% average annual return.
Simple ideas of how much to save and where you ought to be at various points in your life can be useful. But they can also mislead you if the assumptions they make don't apply to you.
Bringing theory to life
The problem with any hypothetical framework like Fidelity's is that you have to make assumptions in order to come up with fixed numbers. Yet if you change the assumptions, the impact on the general guidelines they produce can change dramatically.
For instance, you could easily make an argument that a 5.5% annual return expectation is far too low, especially for younger investors who can afford to invest more aggressively. Despite widespread discontent about lackluster stock-market returns through the decade of the 2000s, more than two-thirds of the stocks in the S&P 500 have beaten that 5.5% figure over the past 10 years. Almost half have managed to post double-digit average annual percentage gains during that timeframe.
Admittedly, to get truly strong gains, you need to have had both foresight and perhaps a bit of luck. Buying priceline.com (Nasdaq: PCLN ) and Akamai (Nasdaq: AKAM ) at their 2002 lows sounds like a no-brainer now, but in the depths of the Internet bust, it seemed quite reasonable to count them out as future contenders. Predicting that they would enjoy such huge recoveries from the downturn would have looked ridiculous.
But you don't have to have taken on huge risks in order to earn solid returns. Even relatively stable companies have stayed the course. McDonald's (NYSE: MCD ) , for instance, has been less than half as volatile as the S&P over the past five years while still returning 19% per year since 2002. Altria (NYSE: MO ) and AutoZone (NYSE: AZO ) have similar risk-reward patterns thanks to solid demand and favorable economic conditions for both companies.
If you can boost your average return, then meeting Fidelity's guidelines will make you even more prepared for retirement and give you room to miss some of its benchmarks along the way. When it comes to saving for retirement, you can use all the breathing room you can get.
Keep on learning
Retirement is an important goal to strive for, but it's not the only one. Please stay tuned throughout the month for other informative articles covering a wide range of important topics. Let me also encourage you to take a look at the special website we've set up at InvestBetterDay.com. On Sept. 25, we're taking a day to celebrate the art of investing, and we encourage your participation. Take a look at the site now and get on the path to personal prosperity.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.