Spending

You may need to halve your number of “safe spends”

Play around long enough with an online retirement calculator and it won’t take long to find the perfect scenario that will allow you to achieve all your financial dreams.

Just modify the inputs enough for the calculations to work.

If your savings amount is insufficient and the market does not offer sufficient returns, push the sliders on the assumption that you will one day save more or achieve greater gains. Work longer and/or spend less and the numbers add up better.

Eventually, even if the assumptions get silly, you can conclude that everything will be fine, even if money is tighter and life is less cushy than you hoped.

Change a few of those assumptions for the worse, though, and you can crush those dreams, to the point where you might have to work an extra decade or more — or die young — to be financially ready for life.

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Right now, the market and the economy are changing Americans’ assumptions. Apply some new math and the situation becomes downright depressing.

Prepare to be depressed, but keep in mind that you can change your habits the same way you change the assumptions on these calculators, which makes a huge difference in the outcome.

The most recent release of results from Northwestern Mutual’s 2022 Planning and Progression Study showed that American adults now believe they will need $1.25 million to retire comfortably.

That’s just over 20% from a year ago, when American adults still thought they needed to hit the $1 million mark to be fixed for life.

It comes at a time when the average American’s retirement savings have fallen more than 10% from 2021, largely due to year-long stock market misery.

There’s no perfect formula giving people “the number,” but an imperfect rule of thumb that many savers follow is that a nest egg should generate 70% of your pre-retirement income each year in retirement.

With prices rising so rapidly this year, consumers are now worried that they have underestimated their savings needs.

Christian Mitchell, chief client officer at Northwestern Mutual, said this week on my “Money Life with Chuck Jaffe” podcast that inflation and market volatility are driving their heightened expectations, “but the biggest problem here is that people’s anxiety about their money is only increasing, they don’t know exactly how much they should save, the world has become a more polarized and unstable place, and so they are massively raising their expectations of savings.

The real problem, however, may be their spending assumptions.

Many retirees plan to live by the “4% rule,” withdrawing 4% of their retirement assets each year in the hope that they won’t outlive their savings.

According to the 4% rule, a $1 million 401(k) would allow you to spend $40,000 adjusted for inflation each year in retirement with minimal chances of outliving your money.

The rule itself is rooted in a 1994 study that financial adviser William Bengen published in the Journal of Financial Planning; Bengen’s calculations showed that a 50-50 stock/bond portfolio would have survived every 30-year period in the United States between 1926 and 1991.

It doesn’t matter that the Center for Retirement Research at Boston College analyzed Federal Reserve data and showed that only 12% of American workers have a retirement account, or that the most recent analysis published by Vanguard Group on its own clients showed that only 15% of retirement accounts at the world’s largest financial company have at least $250,000 or even that this year’s market action pushed average retirement savings below $90,000 in just as consumers were raising their expectations of what they needed.

These numbers show how difficult it can be for many Americans to retire.

The news is in newly published research showing that the 4% rule can be wildly wrong.

A study titled “The Safe Withdrawal Rate: Evidence from a Broad Sample of Developed Markets” – conducted by finance professors and researchers from the University of Arizona and the University of Missouri – updated the Bengen study, with a few key changes, and came to very different conclusions about calculating a safe withdrawal rate.

The authors didn’t guess a recommended number, but rather said that the spending rule you choose depends on how much of your money’s survival risk you’re willing to accept.

Improvements in life expectancy – requiring money to last longer – and the inclusion of returns from 38 developed countries between 1890 and 2019, mean researchers have covered almost 2,500 total years of stock data , bonds and inflation.

While the US has outperformed virtually every developed market over the past century, there’s no guarantee that will last forever; the market experience of all markets could be important if the United States suffers a prolonged regression to the mean.

With that in mind, the researchers said that if you wanted the same probability of outliving your money as Bengen calculated using only US data, the level of safe spending would be more than halved to 1.9%. Ouch.

Spend at the 4% level, according to the authors, and your risk of “financial ruin” is considerably higher.

Generating the same amount of income to spend safely would require more than double the savings.

Consider how scary it was when you read, according to the Northwestern Mutual study, that people thought they needed to save 20% more.

That’s a massive move in the assumption sliders on any retirement calculator, enough to worry almost any savers, especially as inflation persists and longevity risk and yield sequence risk (the danger of a downturn as someone retires impacts a lifetime portfolio) hits pre-retirees in the face.

The only good news here is that these spending rules are designed to avoid emptying a nest egg; you can save less and gradually deplete your savings without becoming destitute or dying broke.

Don’t expect to have your cake and eat it too; the only safe retirement savings assumption we can all make in these times is that the more money we save now, the better off we will be later.