Sometimes people have told me that I shouldn't be so pessimistic, that I should expect more out of this or that. I explain that having low expectations generally works well for me. Because if I have low expectations, I won't end up very disappointed, and there's a greater chance that I'll be pleasantly surprised. It turns out that lowering our expectations can be effective in our financial lives, too.
The "optimism bias"
I recently read a provocative little article in The New York Times by Jim Holt. He explained that:
Research shows that we systematically exaggerate our chances of success, believing ourselves to be more competent and more in control than we actually are. Some 80% of drivers, for example, think they are better at the wheel than the typical motorist and thus less likely to have an accident. We live in a Lake Woebegon of the mind, it seems, where all the children are above average.
He even went on to suggest that this "optimism bias" may help explain our war in Iraq, as those who advocated it assumed it would be easier than it turned out to be.
Misplaced optimism
To see the optimism bias in effect in our financial lives, look at the 2006 Retirement Confidence Survey. It found that:
- 68% of Americans are very or somewhat confident that they'll have enough to live on through retirement.
- But 43% of those aged 55 or more have saved less than $25,000 for their retirements (excluding the value of their homes), and another 8% have saved less than $50,000. More than a third have less than $10,000 socked away!
On what are these folks basing their optimism? Well, apparently, when it comes to determining how much they'll need in retirement, close to half (44%) have simply guessed.
Have high hopes but low expectations
I think we might all be better off if we lowered our financial expectations -- while still aiming high. In other words, we can hope for the best and prepare for the worst (or at least the not-best).
Some people, for example, simply don't know what the historical average annual return of the stock market is. They just assume it's this or that. Some think they can earn 20% or 40% per year in stocks. Think again! The historic average is around 10%, and that's far from guaranteed. During the specific period in which you invest, be it 10 or 20 or 30 years, the average annual return might be 8% or 14% or, more likely, something else.
Let's say you have $50,000 stashed away in an S&P 500 index fund for your retirement in 15 years. If it grows at a compound average rate of 8% per year, you'll end up with nearly $160,000. If it grows at 14%, you'll end up with more than $350,000 -- quite a difference, eh? (Want to figure out how much your next egg will offer you to live on each year in retirement? I learned in our Rule Your Retirement newsletter that between 4% and 5% is a reasonable annual withdrawal rate, so if you have $160,000, plan to carve off around $7,200 in your first year of retirement. That's not too much to live on, is it? With the $350,000, you'll withdraw $15,750 -- still hardly a vast sum.)
What to do now
So what steps should you take now? Well, don't put off saving and investing for retirement. The earlier you begin, the better, because the dollars you invest first will have the longest time in which to grow. Start estimating your needs. Plow as much as you can into your retirement accounts and your brokerage and mutual fund accounts, making sure that you'll have enough to live on even if the market's performance is lackluster in your years. If it grows much more than you planned for, you'll be sitting on gravy that will buy you an extra comfy retirement, or which can be given away to loved ones or charity.
If you want a simple but effective investment, park some or most of your long-term moola in a broad-market index fund such as one based on the S&P 500. It will instantly have you invested in 500 of America's biggest outfits, such as Anheuser-Busch
Read broadly -- our Retirement Center might be a good place to start.
And don't assume that reading and learning about retirement is going to be painful -- it needn't be. Check out our Rule Your Retirement newsletter service, for example -- it's prepared by Robert Brokamp, a smart and witty guy who distills what you really need to know into a manageable volume each month. A free trial will give you full access to all past issues, allowing you to gain valuable tips and even read how some folks have retired early and well.
Here's an immediate opportunity to conquer your financial procrastination a little -- click into and read one of the following articles:
Longtime Fool contributor Selena Maranjian owns shares of no company mentioned herein. Anheuser-Busch is an Inside Value recommendation. For more about Selena, view her bio and her profile. The Motley Fool is Fools writing for Fools.
