Retirement Planning

As time passes, people naturally become more and more concerned about planning properly for retirement. There is a certain amount of financial maturity that must be gathered to devote enough attention and concern to retiring comfortably, and people tend to accrue this at varying rates.

People always value money more in the present and it is natural to do so. This is what is behind a lot of the credit that people obtain, as it’s seen as more beneficial to have it now then to wait until the future and save up for it, so people very often will pay a premium for that, paying more now instead of less later.

The longer the timeframe, the more present money tends to be valued over future money, because each year is going to have a certain discount rate. The more years out the future benefit is, the more it is going to be discounted, because the effect is a cumulative one.

So if one had a choice between enjoying $1000 now, and the same amount in today’s dollars 40 years down the road, all things being equal, one is going to prefer not waiting and enjoying the benefits of this money now.

The closer you get to the date that you will be enjoying it though, the less you will tend to prefer spending it now over later, but people just starting out in their careers are far away from their retirement years and it’s often difficult to focus on an event that far off in time.

With retirement though, all things aren’t equal at all, because retirement means that you will generally have ceased to earn full time employment income, and will need to rely on other sources more in order to maintain the same standard of living.

Money Can Be Worth More In Retirement Though

Money does tend to have a diminishing marginal return though, and this really needs to be taken into account when looking at the prospects of retirement. For example, let’s say you need a car, and will need a car as well in your retirement years, a fair assumption. Let’s also say there are two choices to keep it simple, an economical car for $200 per month and a pricier one for $400 a month.

You will get more benefit from the first $200 a month because you need a car and if you didn’t have this you couldn’t get around let’s say. The second $200 a month doesn’t provide as much bang for the buck as the first $200, so this is why we say it has less marginal value.

So you decide to get the better car and when you get to retirement, you haven’t really saved and now you can’t drive a car at all because you no longer have either the $200 or $400 a month. This is because you spent the money on the nicer car when you were working. If you had saved enough, you would be able to still drive a decent car in retirement.

This is just an example of course but the principle here is that there is going to be a certain amount that you will need just to survive, basic food and shelter, and your income beyond that will always have diminishing value. So you don’t want to consume diminished value in favor of income that would have a greater value later, and this is why retirement savings, at least to the degree that one requires to live comfortably, need to be seen as having a premium value now.

Saving For Retirement Always Depends on Capacity

In economics, there is always a supply side and a demand side, and this principle also applies to planning for retirement. The demand side of things is what you will need in retirement, and we tend to focus too much on that, and we also need to focus on the supply side, our capacity to save for retirement.

When we look at the demand side too much, we can often get discouraged, for instance seeing that reaching a certain retirement goal is out of reach for us, as it very well may be. Retirement planners often use this top down approach, getting you to pick a certain level of retirement income and then telling you how much you’ll need to save per month or year to achieve that.

This can be good to know but what if one is unable to achieve this, or even come close?  This can lead to one losing at least some of their zeal to save for the future and even become despondent about the situation.

While it is often helpful to make these projections to get an idea of what we may expect with a given retirement savings strategy, the plan here always needs to start with capacity, and people have different levels of means to save for retirement. Some may see the projections, this much saved by retirement, and just go ahead and set aside what they will need, while others may see goals that are entirely unrealistic and lose hope.

There is only two ways to save, which are to make more and to spend less, but there’s still only so much you can do, because you cannot go below what you consider to be the minimum standard of living now. You do need to sacrifice some things now to enjoy future retirement benefits, but one must always work with realistic and achievable savings goals.

So it makes a lot more sense to use a bottom up approach to coming up with a retirement savings plan, starting with what one can comfortably achieve, then projecting that and comparing to what one expects to need, and adjusting one’s contributions as one is able to as required and desired.

The Two Pillars Of Retirement Planning

There are two components to this. One of them is investment planning, what you will do with the money that you are setting aside for retirement. This is certainly an important aspect of things, the types of investments you will be seeking, taking full advantage of investments with tax advantages, and so on.

This part tends to get most of the focus, but what is even more fundamental is where this savings is going to come from, in other words looking at our capacity to save for retirement, and seeking to also ensure that this is as much in line with our retirement goals as we need it to be, or that it is as close to allowing for us to achieve our desired goals as we can reasonably make it.

Some people are more thrifty than others, and some are more prone to consumption, consuming now rather than later. If you are going to succeed with your retirement planning, this always will involve sacrifices, unless you have so much money that you don’t know how to spend it all, and if so, you probably don’t have anything to worry about in retirement.

For the rest of us, we probably could spend all of our income as we make it, in other words not setting aside anything for savings, but to save, we need to cut back to some extent. This is the deferring consumption until later that we’re talking about, making a sacrifice of some sort now for the benefit of the future.

Of these two pillars, one’s investment strategy and one’s savings capacity, the savings capacity is the more important of the two, because without a solid plan in place with it, one will not be investing enough or perhaps even investing nothing at all.

There are some people who just don’t have the capacity to save, perhaps just getting by with the basic necessities of life, with no prospects of increasing their income, but in these cases they are doing the best that they can and can only hope that their circumstances change for the better to allow them to one day better prepare for the future.

For most of us though, there are adjustments we can make, and we may already be making them, and we may be able to do better, and perhaps much better, if that’s what’s needed to get us to where we want to be in retirement.

Whenever you defer consumption, provided it’s invested wisely, you don’t give anything up really in the end, you simply defer the benefits. When you defer them to a time where they will be more valuable to you, as in deferring a certain amount for retirement, this isn’t giving up anything in the end, it is gaining something in the end.

A lot of people spend without giving proper consideration to what may be best for them in the long run, and maybe not even think about the long run very much at all, so a lot of us have some real room for improvement here.

This is where retirement planning needs to start, by coming up with a plan to save enough first, and then and only then should we start worrying about how we’re going to save this money to provide good long term prospects for growth while managing risk and maximizing tax benefits.

To the extent that you can execute both pillars well, you will be doing what is needed to ensure that whatever your means, you are putting yourself in the best position you reasonably can to provide for your golden years.