In 1930, the average American's life expectancy was 60 years. Today, it's 78. That's great news. We can now hope to get to know our grandchildren ... and possibly our great-grandchildren, too. But our new-and-improved life expectancies carry some drawbacks, too. Chief among them: They make retirement more complicated and difficult.
To better understand the problem, check out some information I ran across in an article by Alex J. Pollock titled "Retirement Finance: Old Ideas, New Reality." Pollock discusses what he calls the work-to-retirement (W:R) ratio, which divides your number of working years by your number of retirement years. In the past, when people worked longer and lived shorter lives, the ratio was modest. Someone who worked from age 20 until age 70 and then died at 75 would have a ratio of 50:5, or 10. Today, someone who works from age 22 until age 62 and lives to 82 has a ratio of 40:20, or 2. That's a big difference.
Take a look at these
Pollock went on to offer some eye-opening numbers:
A W:R ratio of only 2:1 requires annual savings for retirement alone of over 14% of pretax income throughout one's entire working life. This is hardly feasible for contemporary Americans. In short, with a W:R ratio of only 2:1, the savings rate required to finance retirement, on average, is too high. The W:R ratio, now at a historical low, must rise.
Let's think about that 14%. If you earn $50,000 annually, you'd need to sock away $7,000 each and every year of your working career. Are you? Probably not. In fact, must of us aren't. The national savings rate was recently recorded at negative 0.5%! (If you're hyperventilating now, calm down, breathe into a paper bag for a few minutes, and come right back -- there are solutions to your savings problems.)
Fortunately, as Pollock demonstrates in his article, you can reduce your required savings by working a little longer. If you work from age 22 to age 70 and then live to 86, your ratio will be 48:16, or 3. That brings your required savings rate from 14% of your income to a little less than 10%.
But be sure to keep in mind
Here are some other things to remember when assessing your retirement savings needs:
- Pollock was rather conservative in calculating the return you'd be earning on those savings. He imagined a mix of stocks and bonds that returned approximately 7% annually. You may be able to do better.
- But you may not. So, to be on the safe side, it's best to save as much as you can, because the market may be sluggish over the long run, or some other calamity might occur.
- You might up your chances of earning more than 7% annually by investing in some carefully selected mutual funds or individual stocks. Fellow Fools Tim Hanson and Brian Richards profile some of the best mutual funds of the past 10 years -- all of which averaged 18% (or greater) annual returns.
- You can up your odds of having a comfy retirement by being proactive. Read up on the topic. Plan well. Pay attention to the tax-efficiency of your investments. Maximize IRAs and 401(k)s. Allocate your precious dollars effectively. With a little education, you can enhance your ultimate net worth considerably.
Investing for retirement
One more option to consider is the target-date mutual fund, each of which is designed around a specific retirement date, with its investments chosen accordingly. The Vanguard 2025 (VTTVX) fund, for example, is for those who plan to retire in 2025. It recently had 79% of its assets in stocks and 21% in bonds, whereas its Vanguard 2045 (VTIVX) counterpart had 90% in stocks and 10% in bonds. The fund takes care of shifting your assets as you get older, adding more bonds in later years.
Target-date funds tend to invest in a handful of other funds from the family's lineup. The Vanguard 2025 fund, for example, recently had 61% of its assets in the Vanguard Total Stock Market Index (VTSMX) and 9% in Vanguard European Stock Index (VEURX) -- giving you both domestic and foreign equity exposure. While the former has shareholders invested in the likes of General Electric
Position yourself optimally
For some additional retirement guidance, consider trying our Motley Fool Rule Your Retirement service free for a whole month. Doing so will give you access to all the past issues, which feature a host of success stories that profile people who retired early and are willing to share their strategies. Editor Robert Brokamp also regularly brings you specific stock and fund recommendations that are poised to outperform. Just click here for more information on a free trial. I'm sure you'll like what you see.