When researchers for a recent IPSOS/USA Today survey asked 45-to-65-year olds how prepared they felt for retirement 59% responded that they felt very or somewhat prepared. The same percentage said they expected to rely mostly or entirely on their own savings to fund their post-career life. Asked how much savings they had, however, only about a third had set aside even $250,000, while another third had saved less than $100,000. All of which suggests some people could be in for a rude awakening come retirement time. To get a better handle on whether you’re really on track when it comes to retirement, ask yourself these three key questions.
1. Will you be able to generate enough income to maintain your standard of living in retirement? Growing your nest egg is certainly important, but the balance of your retirement account is actually a less-than-ideal metric for assessing whether you’re making sufficient progress toward a secure retirement. One reason: a sum that can seem almost princely in absolute terms may still be far short of the amount of savings you’ll need to support you for a retirement that could last 30 or more years. For example, a $500,000 nest egg will generate annual inflation-adjusted income of only $20,000 a year or so, if you want reasonable assurance of being able to count on that income the rest of your life.
So rather than homing in on “Your Number,” or the dollar value of your nest egg, focus instead on whether you’re on track to replace enough of your pre-retirement income to allow you to live an acceptable lifestyle once the paychecks stop.
You can do that by going to a retirement planning tool like T. Rowe Price’s retirement income calculator, which you can access through RealDealRetirement.com’s Tools & Calculator’s section. You enter such information as your age, annual income, how much you’ve saved already and how that money is invested, the percentage of salary you’re saving each year, the age at which you expect to retire, any pensions you’re eligible for and your projected Social Security benefit. (You can go with the estimate the tool automatically plugs in, or you can go to Social Security’s Retirement Estimator tool for a figure on your actual earnings history.) The tool will then use Monte Carlo simulations to estimate your chances that you’ll be able to retire with sufficient lifetime retirement income, assuming you continue on your current path. If your odds of achieving a secure retirement are lower than you’re comfortable with, you can see how making adjustments like saving more, investing differently and postponing retirement a year or two might can improve your chances.
2. Do you have the right mix of investments? Generally, the more years you have until you retire, the more of your retirement savings you’ll want to invest in stocks. The idea is that since stocks generate higher long-term returns than bonds, money-market funds and savings accounts, tilting your portfolio toward equities can help you build a larger retirement nest egg. Those higher returns come with more volatility, of course. But when you’re still many years from retirement, you have plenty of time to rebound from stocks’ periodic severe setbacks.
As you age, however, you want to gradually shift your asset mix more toward bonds to avoid getting hit with losses near the end of your career that, if big enough, might force you to postpone retirement or scale back your standard of living. Some people fail to make this crucial transition. For example, an Employee Benefit Research Institute study found that in the months leading up to the 2008 financial crisis—during which stock prices dropped by nearly 60% from their pre-crisis peak to their pre-recovery trough—more than four in ten 56-to-65-year-olds had more than 70% of their 401(k) invested in stocks and nearly 25% had more than 90% of their account in equities, leaving them vulnerable to gut-wrenching setbacks on the eve of retirement.
There’s no single mix of stocks and bonds that’s ideal for all investors. But you can get a sense of what’s right for you at any point in your retirement planning by going to Vanguard’s risk tolerance-asset allocation questionnaire. You answer 11 questions designed to get at issues like what size losses you can tolerate before you start to get anxious, when you expect to begin drawing money from your retirement accounts and how many years you think you’ll be counting on your retirement savings to help support you. The tool will then recommend an appropriate stocks-bonds mix, and also show you how that allocation and others more aggressive and more conservative have performed on average over the past 90 years and in up and down markets.
The portfolio you create doesn’t have to be complicated or chock-a-block with every new fund or ETF the financial services industry churns out. In fact, simpler is better. Your aim is to build a simple-but-effective mix of funds that gives you exposure to all types of stocks (small and large, growth and value) as well as a diversified mix of investment-grade bonds (government and corporate in a range of maturities), which you can do with just a few broadly diversified low-cost index funds (or, if you want to keep things even simpler, a target-date retirement fund).
Once you’ve settled on a stocks-bonds allocation you’re okay with, resist the urge to change it, regardless of pundits’ market predictions (which, as we saw last year in the aftermath of Brexit and Trump’s election, can sometimes be spectacularly wrong). Instead, stick with your mix, except perhaps to rebalance periodically or to shift to a more conservative investing stance as you near and then enter retirement.
3. How will you actually live in retirement? Assuming that you’ll require, say, 70% to 90% of your pre-retirement income after you retire may be okay for estimating how much you need to save when retirement is still several decades away. But once you get within 10 years or so of calling it a career, you want to get a more accurate fix on how much you’ll actually spend. And to do that, you’ll need to do a little “lifestyle planning”—i.e., thinking seriously about how you’ll spend your time in retirement once your 9-to-5 is no longer there to provide structure to your weeks and days.
Among the questions you’ll want to address: Will you stay in your current city or town or relocate to a new area? If you plan to stay where you are, will you remain in your current home or downsize to something that’s less expensive to maintain? Will you travel extensively, or mostly stay close to home? Do you envision working part-time, whether for the money to stay in touch socially? And speaking of staying socially engaged, do you have friends and family you can rely on for companionship and support after you retire? Research shows that retirees who have a solid network of friends and relatives were almost three times more likely to be satisfied with their retirement than those who lacked a circle of friends with whom they could spend time and share activities.
Answering these sorts of questions is important for two reasons. First, the way you live will directly affect your retirement spending. The more active you are and the more you engage in travel and other leisure pursuits, for instance, the more income you’ll need to support your lifestyle. But this sort of planning is also important because it can help you better make the transition from the work-a-day world to retirement. After all, given today’s longer lifespans, you could easily end up spending upwards of 30 or more years in retirement. The better you prepare for that phase of life, the more enjoyable and fulfilling it’s likely to be.
Once you’ve done this sort of planning, you can put some numbers on your retirement vision by doing a rigorous retirement budget. You can then refine the numbers as you get closer to retirement, at which point you can also get a better sense of whether your savings and other resources can actually support the lifestyle you’d like to lead.
Clearly, there are plenty of other issues you’ll need to nail down before you retire, including when to begin collecting Social Security and whether you’d like more guaranteed income than Social Security alone can provide. But if you start with the three questions above and revisit them occasionally as you near the end of your career, you’ll be able to gauge whether you’re actually making progress toward retirement and, more importantly, reduce your chances of heading into retirement believing you’re more prepared than you really are.