If there was a list of cardinal retirement-planning sins, head-in-the-clouds optimism would probably come in second only to not planning at all. We'd all like to think our expenses will decline in retirement and that we won't encounter too many unexpected costs, but there's no way to be sure. Running out of money is a concern for every retiree, but you can mitigate the risk of that happening by injecting a healthy dose of realism into your retirement plan.
Here are three things you don't want to overestimate in your retirement plan as well as how to correct them if you realize you have.
1. How quickly your investments will grow
Good economies and Wall Street bull markets don't last forever, as 2020 has acutely reminded us. Some years, you might see a 7%, 8%, or even 10% rate of return on your investments, but it's not realistic to assume this will happen every year of your working life. Some years, you might only see a 5% or 6% rate of return. And in others, the odds are, the value of your retirement portfolio is going to drop, though hopefully, those overall declines will only be temporary if you've invested in a diversified set of solid, established companies.
The profits you make on your investments will probably account for a substantial portion of your retirement nest egg, but it's important not to overestimate just how profitable those investments will be. For example, if you start with $25,000 in your portfolio, an 8% average annual rate of return over 30 years would leave you with over $251,000. But if you only average a 6% annual rate of return, you'll end up with a little under $144,000. If you're expecting the rosier scenario but get the weaker one, you'll wind up more than $100,000 short of what you expected.
Mistakes like these can leave you without adequate funds for your retirement, so it's best to craft your savings plan based on a lower rate of return on your investments, just in case. Use 5% or 6% per year as your benchmark. If your investments end up performing better than this, you might be able to retire early or enjoy a more comfortable retirement. Or it could leave you with more to pass along to your heirs.
2. How much you'll get from Social Security
You will receive some money from Social Security in retirement as long as you worked for at least 10 years or were married to someone who did. But the benefits that program pays are likely not going to cover all of your expenses -- indeed, it may not even cover half of them. Social Security was only designed to replace about 40% of the average beneficiary's pre-retirement income.
Overestimating the size of your future Social Security checks could also cause you to underestimate how much you'll need to personally save, resulting in a serious shortfall. You can go to the agency's website to create a personalized my Social Security account. This will allow you to get an accurate, up-to-date estimate of what your monthly benefit will be in retirement, based on your work record thus far under the current formula.
That said, the government may cut Social Security benefits in the future if Congress can't agree on a plan to increase funding to the program, so you may want to structure your investment plan based on the idea that you'll receive less than the agency's calculator says. You also need to consider the age at which you plan to begin taking Social Security benefits, as this will have a major impact on the size of your monthly checks.
3. How much you'll be able to save for retirement later on in your career
Younger workers may think they have plenty of time to save for retirement, and that it's fine to contribute less now and make up for it with larger contributions later. But it doesn't always work that way. You can't predict what the future will bring, nor how much you'll be able to save in years to come. The expenses of caring for children or elderly parents might limit the amount of cash you can put toward retirement. Or you could lose your job or become disabled. Or some other impediment could arise that cuts into what you hoped to set aside for your senior years. Regardless, it's just not a good idea to assume saving for retirement will get easier down the road.
Moreover, investing money for your retirement while you're young is actually the best way to make the process easy and lucrative, due to the power of compound growth. If your goal, for example, is to have a $1 million portfolio when you're 65, you'd only have to invest about $381 per month if you started at 25. But if you waited just one year to begin, the monthly contribution required would jump up to $410. And if you didn't start saving until you turned 30, you'd need to set aside $555 per month to hit the same target.
Time is a powerful ally in retirement planning, so rather than postponing those investments, prioritize them as much as you can, as soon as you can. Once you've established a rough estimate of how much you'll require to retire, you should know how much you need to save per month. If you haven't already done so, you can use a retirement calculator to figure this out. Then, aim to meet or exceed this monthly savings goal to cushion yourself against unexpected events that may arise.
These are just a few examples of how too much optimism in your planning could make your retirement more difficult, but it's not a comprehensive list. Go through your entire plan and ask yourself if your estimates are realistic or overly rosy. Consider things like your expected annual spending, the cost of healthcare, and the rate of inflation. If necessary, redo your retirement plan with more realistic numbers. It's better to worry more about the downbeat scenarios now so you'll have less need to worry about running out of money later.