As an investment advisor of nearly 20 years, my intuition increasingly acts as an analytical shortcut. While that’s to be expected as experience accumulates, it is always comforting to see that intuition validated. This recently happened after I reviewed an academic study on retirement and the amazing value of working longer.
The math at work behind the retirement decision really isn’t that complex. There are only a small number of levers to pull. First is your savings rate. Second is your investment return on those savings. Third is the proportion of your retirement lifestyle that your savings won’t need to cover after factoring in your Social Security and – if you are lucky – your pension income. And, the final lever to factor into the retirement equation is, of course, your life expectancy.
This final lever is a bit perverse. Strive to live longer and your retirement hurdle grows higher. Choose the opposite and your retirement challenge becomes a cake walk. In the end, however, this is nothing but a Hobson’s choice for most of us. As humans, we don’t really control this lever as our will for a long and healthy life is quite inherent.
Each of the controllable retirement levers have built in sensitivities. A way to measure these sensitivities is to see how much a slight tweak on each lever might affect the level of available financial resources in retirement.
For example, you could choose to save a little more and your sustainable retirement income will obviously go up. Or, you could work to lower the cost of your investment program – which directly boosts the investment returns you get to keep – and, naturally, your retirement resources would rise.
In fact, this academic study showed that a small boost of your annual savings rate by 1% more starting at age 36 might produce a 4% boost in your annual income during your retirement years. The longer you wait to increase your savings rate, the smaller your bang is for the buck. Like the classic advice on voting, you should save early and often!
Now, what happens if you could also get better returns on your savings? The study showed that if you were able to boost your investment returns by 0.5% per year during your working years, your sustainable retirement income might also increase by as similar 4% per year.
Doing both things – as easy as walking and chewing gum at the same time – could boost your retirement lifestyle by closer to 8% per year. Since percentages aren’t all that easy to visualize, let’s just say this would translate into a lot of nice experiences over your retirement years!
Importantly, these basic planning moves – moderately boosting your savings rate and your investment returns – are both time-tested and largely controllable.
But, what about simply working longer? How much longer would you need to keep working to equal the impact of saving 1% more of your income for your entire career and squeezing out 0.5% more return on your investments each and every year? Drumroll, please! The answer is you wouldn’t need to delay your retirement for even one full year!
So, here’s some truly intuitive advice. Be sure to save early and save often, and then, find work you enjoy, with people you enjoy, and keep at it for as long as you can.
Jason P. Tank, CFA is the owner of Front Street Wealth Management, a fee-only wealth advisory firm located in Traverse City. Contact him at (231) 947-3775, by email at [email protected] and at www.FrontStreet.com
