Saving for retirement can often seem confusing because everybody seems to have a different strategy for dealing with the problem. While there is really no single correct solution, we also have to deal with widely accepted theories that are not entirely true. It's critical that we double check all the facts before we settle on a retirement plan. Here are four widely accepted, yet misleading pieces of retirement advice.
[See 10 Places to Retire on Social Security Alone.]
Your house is a major investment for your retirement. Before the housing crisis, many people felt that their primary residence was a great long-term investment. Even now, you will hear people say that the house they live in will be a good asset to draw from if it's fully paid for. Yet, unless you can sell your house and not ever worry about where you will live, your house is an illiquid asset that won't net you much money unless you downsize significantly because of the moving and transaction costs associated with buying and selling your house.
Let's say your house increases in value to $1 million when you retire. That sounds great, right? Yet, if you decide to sell it, you will have to pay 6 percent on the $1 million. Add in moving costs and fixes to your house before you sell and 7 percent might be closer to reality. Part of that money will need to be used to purchase a new place to live. Let’s say a small condo in your neighborhood costs $750,000 and needs $10,000 worth of renovations and cosmetic touch-ups. When it’s all said and done, you net about $180,000. While $180,000 is a lot of money, is it enough to sacrifice the house that you've loved being in for decades?
[See 4 Situations When You Shouldn’t Save for Retirement.]
The 4 percent withdrawal rule is a set it and forget it approach. Many people plan to withdraw 4 percent of their savings each year in retirement, and slightly increase the amount each year by the rate of inflation. But this strategy isn't even close to bulletproof. A recent T. Rowe Price study put this theory to the test by simulating a portfolio consisting of 55 percent stocks and 45 percent bonds. During the 10,000 Monte Carlo simulations the researchers ran, retirees ran out of money within 30 years in 71 percent of the scenarios if the first several years of withdrawals happened during a bear market. A consistent 4 percent withdrawal rate isn’t really safe at all. If you happen to retire during a bear market, consider withdrawing less money or simply delaying your retirement for a few years.
Your money stops growing in retirement. People seem to forget that the only change when the paycheck stops coming is exactly that. Just because contributions to your nest egg stop, doesn't mean your money stops growing. In a well-devised retirement plan that is supposed to last decades after you decide to quit working, your nest egg will still grow for a number of years past your retirement age. If this isn't happening during the first few years of your retirement, you should take immediate action such as finding part-time work or mastering frugal living. Attempting to withdraw less from your retirement savings will be crucial in prolonging the time that the money you've accumulated for retirement will last.
Time is the most important part of growth. Many people saving for retirement wish they had started saving younger. If you had invested $10,000 in the stock market 25 years ago and contributed to that nest egg regularly, you would likely be a multi-millionaire by now. Yet, there are lots of assumptions with this statement. Would you be able to leave all your money in the stock market through the ups and downs for 40 straight years? Would you live as frugally as you do now and be able to contribute for 25 years, even though you could have increased your standard of living? Did you actually ever have an extra $10,000 to invest 25 years ago, which would likely have been more like $30,000 in today's dollars?
[See How to Prevent Outliving Your Retirement Savings.]
Thinking about the time value of money if you started saving when you were born is nice, but sometimes it's just unreasonable to assume that it's a scenario that could have happened to you. For people like us who actually live a real life, our rate of savings from this point forward (the amount that we can actually contribute to our retirement fund) is much more dependable and realistic. The best part is that our savings rate is, for the most part, controllable. For many of us, if you clip a few coupons, skip a few dinners out, and stop making impulse purchases, it’s fairly easy to increase your savings rate by a percent or two.
David Ning runs MoneyNing, a personal finance site aimed at helping others change their habits for a better financial future. He suggests that everyone to sign up for an online savings account to get more out of our hard earned money.
Reader Comments Read all comments (1)
Mike of MA 1:05PM July 27, 2011