I came across an article on CNN (though it could have been any major news/content outlet) about why you should increase your 401k contributions – which as far as personal finance advice goes, I’m all for. It even suggested that you HAVE to at least match your employer contributions or you’re losing out on free money!
But it doesn’t take long for the advice to get a little haywire.
You see, the issue isn’t should you be saving (you should!). It’s how much to save.
Common “knowledge” is that you need to have enough money saved to be able to replace up to 80% of your salary in retirement. If you’re counting on Social Security, you might only need 40%. Either way, you still have to figure out “your number”. Luckily, a handy formula was provided:
- Multiply your salary by 40% (0.4)
- According to the “4% rule” of retirement, you can safely expect to withdraw 4% of your retirement savings your first year of retirement, and then adjust for inflation in subsequent years. So, multiply the amount from step one by 25 (or divide by 4%).
- This is how much you’ll need in savings.
I assume the “4% rule of retirement” is referring to the 4% Safe Withdrawal Rate Rule Of Thumb from the Trinity Study. But the Trinity Study tested portfolios that had a mix of stocks and bonds, and examined how those investment returns would allow the portfolio to provide a yearly income that would rise with inflation and not deplete all your money.
Nowhere in the article was there any mention of stocks, bonds, or actual investment returns. These are critical components to understand when it comes to investing and retirement planning. The fact that they’re omitted is scary. Do they think readers will stop reading the second they see the word “stocks” or “investing”?
It’s no wonder retirement planning seems like rocket science to so many people. There are so many variables and the important ones aren’t even mentioned! Let alone the “rule” that your nest egg should be based off your income (they don’t even specify that! Is it your highest earning year, an average, or your last working years?). So the one formula that is provided doesn’t even give you “your number“!
Ever wonder why most people can’t picture their retirement, let alone tell you how much they think they’ll need? Because the common advice is what you see above. That vague formula, the omission of anything related to investing and no reference to spending as factors in that final number.
It’s why we think we need advisers and professionals and obscene math skills and a year off work so we can learn how the stock market works.
And it’s not even the advice that’s necessarily complicated – it’s what the advice is asking people to do – imagine a future based off a bunch of unknowns with only some of the data.
Most of us don’t go into a restaurant and order something new without asking what’s in it first, right?
Image by Sira Anamwong at FreeDigitalPhotos.net