I have spent a lot of time thinking about the best way to estimate how large of a nest egg we will need to retire. I have concluded that there is only one practical way to do this and it involves creating a comprehensive retirement spending budget. Many so-called experts suggest using an income replacement ratio or an income multiplier to arrive at a retirement “number.” In my humble opinion, that is a flawed approach.
This is just a ridiculous generalization.
The New York Times Bucks blog wrote about the study. One of the commenters explained the flaw perfectly:
Assume that retiree A earned $50k annually his last year of retirement and spent every penny.
Assume that retiree B earned $100k annually her last year of retirement, spending half and saving half. (Certainly possible for a semi-frugal empty nester.)
Retiree A and retiree B have the same pre-retirement standard of living: $50,000 in annual lifestyle spending. Yet, according to the “study”, retiree A needs to have saved $550K to maintain that standard of living in retirement while retiree B is supposed to have saved $1.1 million.
Is this even close to making sense? No.
Why do people even publish these reports? Will it scare folks? Yes. Will it scare them so much that they just say “it’s hopeless” and give up? Possibly.
You cannot draw conclusions like this based on averages or medians. You have to determine retirement savings needs based on personalized spending needs and patterns. Ideally, most pre-retirees are saving and investing a substantial portion of their pre-retirement income and/or using income to eliminate mortgage debt. They won’t need to replace that portion of their spending when they retire.
I created a retirement spending plan and budget for us three years ago even though I have no plans to stop working in the near future. I update that budget regularly with current data. I use that budget to set savings targets for us. I use that budget to determine our investment risk tolerance. That is the way it should be done. Everything else is a rule of thumb gimmick.
Do you agree or disagree?