Allocating Resources to Retirement

The Need to Scrutinize in Deciding Retirement Allocations

People do tend to pay a fair bit of attention to how much they decide to save up for retirement, although this is too important of a topic for most people to be left to off the cuff judgements. The decisions we make all along the way toward the road to retirement may have some serious consequences later, and there are no do overs here, as we cannot go back in time and change our strategies, we can only look forward.

The focus here tends to be too much on what we’ll need, on the future, and not enough on what we can do, on the present. We need to be aware of both, and if anything, looking at our allocations of our disposable income every step of the way to decide what portion we are going to enjoy now and what allotment we’re setting aside for the future, including in retirement, matters even more.

If we just shoot for some objective standard in retirement, usually the minimum that we see ourselves needing, this can leave us with less than ideal future allocations, where we could have comfortably done more and received more value overall, or end up leaving us discouraged if we cannot reasonably achieve these goals, and perhaps even seeing us disheartened and giving up.

We should instead take a more analytical approach to deciding how much of our resources we should devote to the present and how much to the future, although this need not involve anything too complicated. It should be based upon a desire to manage our life with a view of getting the most out of our money, where we resist the temptation to discount future value too much and approach all of this from a longer term management perspective.

The ideal here from a theoretical perspective should be to not have retirement impact our lives at all, where we just transition from working to retirement with no financial impact whatsoever. We may even choose to elevate our lifestyle in retirement, or to at least allow ourselves to do so if we choose.

We may and should also look to create a buffer, additional resources that can be used for unplanned expenses, and getting this all right involves more than just having enough money to live comfortably. It also requires us to deal with other expenses that may arise, as they always can, and perhaps especially in our later years if anything.

Retirement Planning Requires That We Not Discount Future Value

The approach needs to start with our current resources though, because this is always the context of when these decisions are made, and always involves our deciding to allocate a certain amount of our resources to the future rather than to the present.

It is very natural for people to discount future value, and it’s also generally quite sensible to do so. There are some practical reasons to do this, for instance we never can be completely sure that we’ll be around to enjoy the assets that we defer to the future, but most of this discounting is driven by psychological factors, the desire to have something now versus later.

Some people are more prone to these desires than others, but this is something that can and does need to be managed wisely, if we seek an outcome that is based more upon wisdom and less upon impulse.

The impulses that drive us to allocate too much of our resources to the present and end up discounting the future too much can be pretty strong though, and this represents the biggest challenge for most people to actually do the right thing and prepare for retirement ideally or even well.

All spending decisions that go beyond our basic necessities involve one that chooses present value over future value, although there is a tendency to define necessities too broadly. Necessities are just that, what is needed to keep things going, and the defining characteristic of a necessity is one that we cannot choose to defer.

Whenever we can choose though, this now becomes a decision regarding disposable income, and we at least need to be aware of this, so we can at least attempt to make the correct decisions overall, whether we should choose differently or not.

It will often make sense to enjoy a certain amount of disposable income now, and we should be out for seeking to maintain a certain lifestyle according to our means, both now and later. If we allocate too much to the now though, this can leave us short later, and looking to smooth this curve and not endure retirement shock that relegates us to sinking beyond what we consider to be comfortable should be sought to be avoided.

To do this, this is going to involve our not valuing the present over the future, because the plan requires us to value the future in a similar way, given that the focus of retirement planning is to take care of the future and strive for long term security and comfort.

This can be quite challenging for many people, especially those driven by impulsive spending, spending that does not properly account for the long term consequences of the actions. This is the reason why most people end up being disappointed in retirement, because they were not able to pay as much heed to the future as they did the present, and end up suffering the consequences.

It Takes a Lot to Replace One’s Income

Our goal of maintaining our lifestyle into retirement tends to be a bigger challenge than most people realize, especially given the longer life expectancies we see today, which are projected to get even longer in the future.

If we work for 40 years and expect to spend our last 20 years in retirement, we probably aren’t going to set ourselves up very well by just devoting a small portion of our income while working aside for this.

If we make $50,000 a year after taxes, say, and we’re looking to keep that going after retirement, for 20 years, this means we’ll need a million dollars set aside in today’s dollars, which doesn’t even include taxes, but we can set this aside for the purposes of this illustration.

While we may invest during these working years and expect to gain from that, we also need to be realistic about our returns and also consider that we need to subtract inflation from what we expect to get, because we need this $50,000 a year in today’s money, not inflated money.

The higher one’s expected investment returns, the less we need to invest, but based upon the way people invest, using a passive strategy that just seeks out market returns at best, the returns that this strategy produces tends to be pretty modest over time, and isn’t going to multiply our capital by all that much.

It will primarily come down to putting enough into our retirement savings to achieve this goal, and given our 40 year/20 year split, ignoring returns and inflation, we’re going to need to save half of our income for retirement to achieve this.

It is reasonable to assume that we can project at least a modest rate of return over inflation though, which will reduce the amount we’ll need to save, as saving half of one’s income for retirement is something that people will find to be too difficult.

With a 3% rate of return over inflation though, which is both reasonable and realistic based upon past performance, we’d still need to set aside $14,000 a year, every year, for 40 years, to reach our goal of the million dollars.

This is a goal that is plenty challenging enough, and may be too challenging depending on one’s level of income, as the more income you have the easier it is to devote a certain percentage of it to retirement. If you only make $25,000 after taxes, devoting this 28% to retirement is going to be much more difficult than if you make $250,000 for instance.

For most people though, this bar is going to be set pretty high and it probably won’t be even a matter of being able to control their spending enough to reach it, it will probably be more a matter of trying to come as close as they can to it, but coming closer is certainly better than being further away.

Should we get a late start to this, and younger people tend to discount the future even more, this is going to make the goal much more challenging. With just 20 years to work with for example, we now will have to devote $40,000 of our $50,000 to retirement, which is well beyond what would be reasonable. The best one can do in this model is to look to minimize the pain.

Improving Returns Can Make a Big Difference

While devoting more of your income to retirement is certainly something that is beneficial to succeeding with a retirement plan, it isn’t the only way to help yourself here. If we can substantially increase our rate of return on our investments, we can really help ourselves here, in a big way.

If, for instance, we achieve a 10% return over inflation over this time, we only need to set aside 5% of our income instead of 28% to get to our million dollars in today’s money. 5% is a very modest amount, where 28% may often be too unrealistic.

If one is looking to catch up, this can take us from hopeless to at least getting much closer to our goal. Even with better returns such as this, getting a late start is going to be a challenge for sure, but with 20 years left, the 28% will get us at least pretty close to our goal, with $800,000, as opposed to only having less than half of that with a 3% net return.

It is not really about achieving the goal, it’s about achieving it as best we can, and striving for better returns, if one has the means to do so, can be a huge benefit to those looking to save for retirement.

Needless to say though, you won’t get here merely by looking to ride the waves of the stock market, as this will require a more active approach than that, either investing in hedge funds that can produce these sort of returns, or investing yourself.

It’s really not that hard to produce these results yourself, or better, if you know what you are doing, but hardly anyone does nor do they have much of a desire to learn the skills necessary to manage their own investments more profitably.

This is not an arena that one wants to enter into without adequate preparation though, and this does require that one devote oneself to learning how to do this, and especially to wait until one is capable enough before jumping in and putting one’s retirement savings on the line.

Ultimately, we all need to make sure we’re doing enough thinking about how we are going to approach saving for retirement, and not just contribute a certain amount and hope that will be enough. It very often isn’t. There’s too much on the line for us to not think about all of this enough, and if not, we will wish we had, but at a time where it is too late for that.