Several weeks ago, I attempted to write a post about compound interest and the caveats involved in that. I soon realized that I wasn’t explaining my point right, and yanked the post. But I’m back at work on it as I’m writing about savings and retirement for my (as yet untitled) money book.
What I was attempting to say is that a common theme of personal finance books is to tell people that saving and investing small amounts of money over time adds up, due to the miracle of compound interest. This is true, to a degree. For instance, if you invested $3000 a year in the S&P 500 from 1970 to 2009, you would have achieved a rate of return of 10.38%, and the $120,000 you’d invested would have turned into $1.625 million. Investing $6000 per year — just $500 a month — would give you $3.251 million.
This is a fair chunk of change. But there are a few things to keep in mind. Most notably, this doesn’t take into account inflation. Investing $3000 a year seems relatively doable now, in 2010. This is less than $10 a day. Cut out a few coffees, lunches, movies and mall trips and you could probably find the cash. Saving $6000 a year would be more of a stretch, but this is still only 12% of the average household income of $50,000.
Saving $3000 a year back in 1970, however, would be an entirely different matter. The average household income then was less than $9000 per year. Telling a young person then to invest $3000 a year would be like telling a young person now “Hey, all you have to do to have a secure retirement is invest $17,000 per year!” True, but not particularly helpful. In terms of household income, $6000 would have the sticker value of about $34,000 today. Very few 25-year-olds can sock that away.
That doesn’t mean that people shouldn’t save for retirement. The best reason is that most retirement funds are tax advantaged, plus many employers match contributions. So that’s easy money. Which is why it’s fascinating to learn how little most people have saved up. I’ve spent some time today reading the Employee Benefits Research Institute’s 2010 Retirement Confidence Survey. Some 54% of workers have less than $25,000 in savings and investments. Only 18% of workers who are older than 45 have more than $250,000 in savings. The survey notes that many people underestimate how much money they’ll need for retirement, though this is partly a matter of how you calculate it. If you use the rule of thumb that you can pull out 4% of your assets per year, pulling out just $2000 a month ($24,000 a year) would require you to have at least $600,000 in assets.
Anyway, what all this points to is that most people would find it very difficult to save up enough of their income from ages 25-65 to live for 20-30 years with no new money coming in. I don’t want to get much into Social Security, but far from being an argument for the program, I’d note that Social Security has the same problem in that it’s not clear that overall payroll taxes are enough to support multi-decade retirements either. That’s why people are worried about its solvency.
But here’s a different question: why are we so into the idea of retirement? The whole financial planning industry is based on this idea of having enough money to not work, and yet surveys of Americans find that two-thirds of adults say that they would continue to work if they won the lottery. Perhaps people are thinking that, if they were financially secure, they’d be able to do work they loved and not think about money first. But then that suggests this idea: instead of fixating on retirement, we should put that same mental energy into figuring out what kind of work we’d never want to retire from.
To be sure, we will probably all reach some age where we will not be capable of working. But for many of us, that is not 62. Indeed, given that I’m home with a 1-year-old today due to a babysitting issue, I’d wager that I will find it easier to focus on my career at 62 than I do at 32!
This is an interesting post. I once calculated that I’d need to save something like $1 million to have the sort of retirement I’d like- you know, where I get to travel as much as I’d like, eat out a lot, and live in comfort. I don’t know if I’ll get there- in my industry, most companies are small, and don’t match your retirement contributions. Even the one company that I worked at that did have a match capped it at $2k. $1 million is a lot to come up with on your own, compound interest or no. But I’d at least like to get to the point where I can be a consultant, and maybe turn down some jobs because a vacation in the Greek Isles (or a stint watching my grandkids!) sounds better.
I think we’re entering a new era as far as retirement goes. Most people don’t have pensions, but most of us haven’t saved enough to make up for that fact. I don’t think we’re all going to have second careers as Wal-Mart greeters. But maybe we are all going to find ourselves having second careers.
@Cloud – the interesting things is that work is becoming more flexible on the margins, which turns out to be good for seniors too. One of the reasons people want to retire is they want time to travel, volunteer, visit family, etc. They don’t want to wake up to an alarm and commute every morning. But if you could take time off or have a flexible schedule while working, then retirement wouldn’t seem as appealing. Because there are many positives (income, social opportunities, a sense of purpose) gained through working as well.
I totally agree. And if you consider that a pregnancy after age 35 is considered high-risk – or really that any pregnancy from age 35 on is considered high-risk, and say 25 to 35 are key babymaking and raising years — and adoption is very difficult and expensive — the idea that a woman would want to retire at age 60 is even more of a stretch — because most women — and men do have to cut back a bit when their kids are little. Not that women with babies don’t want to work but that after having raised a family most working women — and maybe men too — would really want to focus from 60 to whenever they can–
on interesting work regardless of income, not on not-working. Actually studies show that older men — men over age 65 are among the most clinically depressed – that is they have the highest rates of depression — and why is this? Because when they stop working and look for that pot of gold they realize work is a big part of what helps people self-actualize – not all of it, having a family etc. is a big thing or being able to use your body and exercise or sleep well — but a big part.
We are putting away something for retirement, but I don’t want it to be my total focus right now — or ever really. I want to focus on growing our business and on spending quality time with my kids and on self-growth and self-actualization such that when I am 60 I will know best what I want out of life and will see evolution in myself, and my family etc.
I’d like to read more on what makes people happy with regard to money — The Happiness Project really doesn’t touch that much on this — and how to know say hey should I spent my money here or here or save here or here… There is never enough time or money so it is a matter of priorities.
@Cara- this is a reason some older women give for working longer: they started their careers late (like mid-late 30s) and so are just getting into the swing of things as they round 60. The idea that you’d start your career in your 20s and work non-stop is a very male notion. Since women often take years out to care for children, working longer is a way to compensate.
How about A Penny Earned Is a Penny Saved as a title or chapter title for your money book?
@Gwen – I like that title… may have to use in a chapter somewhere!
Great line: “Instead of fixating on retirement, we should put that same mental energy into figuring out what kind of work we’d never want to retire from.”
So true! I think I started thinking that way when I was 32. Now at 40, I’m living the life of my dreams. So glad I didn’t wait till 62.
Great post…
@Chris – thanks! I, too, am so happy to do what I love. It has been hard to spend time and effort building my career at the same time I have little kids (something I *know* you know about!) but it is because I love what I do that I am able to do it. I think people do best when they love the “stuff” of their job, and have a lot of autonomy, challenge, and hopefully a positive social network as well. There’s no reason to wait for retirement to get autonomy over your time, spend time with people you love, and challenge yourself with new things.