It’s hard to sift through all the advice about saving and investing for retirement that swirls around us on a daily basis.
In this article, we’re going to help punch through the confusion by banishing five common myths about investing for retirement. Some of the myth-busting might be scary, and some should be encouraging. But most importantly, it should make you more confident that you’re grounded in reality when investing for your retirement.
Myth #1: There’s No Point Saving Small Amounts When I’m Young. I’ll Wait Until I’m Older and Can Save More.
Wrong! The best ally you have in your quest for a big retirement portfolio is time. The longer you invest, the longer the returns on those investments can be reinvested, and the bigger that pile of money grows. That is especially true when you can save in a tax-deferred account like a 401(k) or IRA.
Example: Joe and Mary are both 25 years old. Joe decides to save $2,500 a year (less than $50 a week) until he turns 65. Mary postpones saving until she’s 45, but she saves $5,000 every year, twice as much as Joe. When they both reach 65, they will have put the same total amount ($100,000) into their accounts. Guess who has more when they retire at 65? Joe wins, and it’s not even close. Making simple assumptions about investment returns, Joe would have about $318,000, but Mary would have less than $174,000. In other words, Joe would have about 1.8 times as much as Mary. This is the magic of compounding interest. Saving early, even in small amounts, really helps.
Myth #2: Saving 15% of Your Income for Retirement Is Enough.
Not necessarily, especially not if you waited before you started saving. (See Myth #1 above.) Doctors and others who spend many years in school before earning a decent salary have to “play catch-up” by saving more than 15% of their annual income, and this might apply to you. If you postponed saving until your 30s you should put away more than 15% of your income. If you waited until your 40s, you have a lot of catching up to do – save aggressively.
Keep in mind that while your living expenses may decline after you retire, they might not. (That’s a retirement myth but not a myth about investing.) Also note that if your parents and grandparents lived well into their 80s, there’s a good chance you will too. That means you’ll be retired for 20 years or more. You need your retirement savings to last as long as you do.
Myth #3: I Can Expect My Retirement Savings to Earn a Blend of the Average Return on the Stock Market and the Average Yield on Treasury Securities.
While this sounds perfectly reasonable, there are some significant assumptions buried in that statement. First, it assumes you actually invest your retirement savings in stocks and bonds. If you keep that money in bank CDs or hold most of it in just a few stocks, the statement won’t be right for you.
Another problem: There is no clearly defined, undisputed “long-term average” you can count on for your investment earnings. The “average” return depends upon the period used to calculate it. Should you use data from the past ten years? That would exclude the Financial Crisis. (Is that good or bad?) Is longer better? How about the past 40 years? That goes back to the days when U.S. inflation was at 15%, and China was a minor player in the global economy. Does that make sense for projecting what you’ll earn going forward?
Averages are great for many things, but they can be tricky when making predictions. The truth is, no one knows what will happen in the markets over the coming decades. To be on the safe side, save more and assume you’ll earn a reasonably low rate of return. If you end up saving more than you need, that’s okay!
Myth #4: The Percent of My Money Invested in Stocks Should Equal 100 Minus My Age.
This myth is saying that if you’re 55 you should have 45% of your money in stocks, and so on. (And yes, when you’re 100 you should have all of your money in bonds.) This rule of thumb was based on the idea that you can’t afford to chase higher returns from the stock market as you get older. You need the safety of regular income that bonds provide.
The counterargument is you may need to take some risk. In other words, you may need to keep more of your money in stocks to generate the returns you need to cover your expenses in retirement. Most investment pros now recommend people keep a higher percentage in stocks than this rule would allow.
Myth #5: $1 Million Is Enough for a Retirement Nest Egg.
As a professor, when I taught Corporate Finance to MBA students, my answer to questions was often, “It depends.” That’s the answer to “Is $1 million enough?” It depends on:
- how much retirement income you’ll have from other sources such as Social Security or a pension;
- what your living expenses will be, including medical costs not covered by Medicare (probably higher than you think); and
- how long you plan to live (the longer you live, the smaller that $1 million starts to look).
If you expect to live modestly in an area where the cost of living is relatively low, have some income from other sources, and don’t live to be 90+, there’s a good chance that $1 million will be enough. But if you want to travel after you retire and/or live in a city where expenses (including taxes) are high, or there are cutbacks in Social Security, and you live to 90+, $1 million might not be enough. One thing is sure: Having $1 million in retirement savings is a lot better than not having those savings.
Bonus Myth Debunked: Social Security Won’t Be Around When I Retire.
Not true. The reality as of now is that Social Security will not be able to fund 100% of retiree benefits starting around 2037. That doesn’t mean people will receive no benefits. Also, Congress may make changes before then to prop up the system. So, while it’s a good idea to plan for some cut in benefits, don’t believe it when people say the entire system will be “bankrupt” by the time you retire – it’s simply not true.
One thing that is true: Time flies, and it flies faster as you get older. Stop telling yourself that retirement is a long way away and there are other, more pressing things demanding your attention right now. Start saving now and keep it up. Your older self will thank you.
Try this tool to calculate your retirement income: