Replacement Rate; Hokum and Hooey

The WSJ's Total Return Blog shared some of the conclusion about magic retirement numbers from a report by the Boston College Center for Retirement Research. The key takeaway from the WSJ's viewpoint was people need 80% of their preretirement income and that socking away that much requires an 18% savings rate assuming 4% total annual return (there were other assumptions behind the numbers).

I like the idea of a very conservative estimated return but beyond that I think the entire framing is incorrect. As we've gone over quite a few times before, the thing that matters is expenses not income. Taking this perspective allows for more control in terms of planning to reduce expenses and hopefully being being less susceptible to the vagaries of the market.

If global stock markets generally do not double in the next 7.2 years (rule of 72) then it is probably not realistic to expect your portfolio to double in that time.

Some expenses have reasonable visibility like utilities and so could be cut if needed. For example we have two phone lines, a very robust programming package from Directv and we have two smart phones. We could literally cut those expenses in half if we needed to.

Some expenses may not have great visibility like various insurances, home heating costs, groceries and prescriptions. We talked about health insurance the other day and maybe we should count on 15% increases per year? There is obviously volatility in heating but sometimes that might work in the favor of consumers. With some coupon diligence grocery expense can be helped a little and prescriptions; some may go down for going generic and some may go up for who knows what reason.

Then there are one-offs like home repairs, car repairs, vet bills and all the other things like this I've brought up in the past. Add to this list for some people is adult children moving back in due to their own hardship. Someone we know up here had their 40-ish year old son move back in. This could be a net gain if the son pays rent but depending on the situation it could also be a net expense of course.

This also leads to a conversation about living in less house than you can afford, driving less car than you can afford and holding on to that vehicle a little longer and when you make discretionary purchases not doing so on credit (other than a rewards card you pay off immediately).

Over the years I have tried to convey that there are many expenses that come out of nowhere and this seems to be corroborated by reader input. To me this places the emphasis on reducing expenses that can be controlled (somewhat).

If you live a $90,000 lifestyle because your gross income is $140,000 then by using the BC report as a guide your portfolio needs to be $1.2 million to maintain the lifestyle. I get there by taking 80% of the $90,000 which is $72,000, I subtract $24,000 from that for social security (which might not be a correct figure) to get $48,000 and then divide by 0.04 to use the 4% rule.

Fill in your own numbers and decide whether you want to plan on social security (despite the above I don't plan on getting it). What number do you need? Where are you now? How much time do have to make up the difference (by both growth and additional savings)? Do you even want to retire?

Maybe you can save the 18% but what if you can't or what if a 4% total return is actually unrealistic (that would certainly be brutal)? Based on what we know about savings rates and 401k balances saving 18% seems very unrealistic for the general public and even then 18% may not be enough.

If, I say if, 18% is unrealistic yet that is the required savings rate then conceivably this invalidates the entire concept of a magic number. I contend that getting expenses down is a bigger priority because it is more within peoples control. Further, whatever your magic number supposedly is, it has no meaning when you actually retire. Whatever you have on that day is what has meaning. If it is not "enough" then you have adapt one way or the other.

I am all for saving as much as possible but the idea of a magic number is on shaky ground because even if you do get that number something could go wrong and derail the plan. It boils down to save more, spend less and I will add be ready to adapt.