Retirement is big business these days. With the last of the Baby Boom generation reaching retirement age and Generations X, Y, and Z now responsible for their own financial security, banks, brokerages and investment firms are tripping over themselves to sell us on what we should do to successfully save for old age. The truth is that a lot of the most common advice you’ll hear repeated over and over again are now myths. The advice is used because it is easy to understand or used to be true — decades ago. However, these days it has very little practical use. In many cases, it’s no longer accurate. Here are five of the most common and egregious myths promoted about saving for retirement.
The Coffee Myth
This is a very simplistic and somewhat silly adage pushed by the financial industry. It goes that if you took the $2-to-$5 a day that you spend buying a coffee and invested it, it would add up over time and allow you to retire. Here’s some real financial advice: Buy the coffee.
The truth is that nobody is retiring comfortably by investing $2 a day, $10 a week or $40 a month. A simple calculation proves the point. If you invested $40 a month for 30 years and earned a decent annual rate of return of 5%, in the end you’d have saved just around $32,000. Nobody is retiring on that amount.
If you still want to forgo a daily coffee and put that money towards your retirement savings, that would be fine. However, it’s not going to be nearly enough. To say that simply investing the equivalent of a coffee a day will lead to a secure retirement is overly simplistic and, frankly, a little irresponsible. Most people will need to save hundreds, even thousands, of dollars a month from a young age to have a comfortable or affluent lifestyle in retirement. Denying yourself a coffee isn’t going to get you across the finish line. Drink up!
The Million Dollar Myth
One of the more popular blanket statements espoused by the financial industry is that we all need to save $1 million by the time we’re 65 if we hope to live comfortably in retirement. The problem with this statement is that it doesn’t consider people’s individual circumstances.
Does your partner work? Do you and/or your partner have a retirement plan through work? Where do you plan to live in retirement? Do you plan to carry a mortgage or have any debt in retirement? Will you receive the maximum amount in Social Security payments in old age? What age would you like to retire at? What do you plan to do once retired – travel or stay home and work in the garden?
These are just a few of the personal questions that will determine exactly how much money you need once retired. Simply saying that we all need $1 million is like saying everyone should own a four-bedroom house. It’s a statement that does not apply to everyone. To truly know how much money you’ll need requires a complex calculation that considers your unique circumstances and those of your family. Besides, the $1 million figure is a bit antiquated. A recent (2019) survey carried out by Schwab Retirement Plan Services found that most Americans believe they’ll need at least $1.7 million to retire comfortably. The best advice is to save as much money as you can. Period.
Annual Interest Earned Myth
This is one of the cruelest myths peddled by financial salespeople. It pertains to how much interest your investments earn. Compound interest can have a big impact on retirement savings. Over time, how much interest you earn on your investments determines how much money you have in your nest egg.
The problem is that the financial industry (mutual fund managers) can grossly overstate the return on investment they achieve for clients. The standard used to be a promise of a 7% or 8% annualized return. That figure has dropped in recent years to around 5%. However, it’s still often an overstatement. The truth is that most people are lucky if they earn a 3% annual return on their investments over a long period. That’s usually before fees are deducted, too.
Data found online is all over the place and often self-serving, but mutual funds over the last 20 years have averaged an annualized return of about 3.3%. However, once the Management Expense Ratio (MER) is deducted, that return to the investor is usually less than 2%. Often, the interest earned on investments is less than the rate of inflation.
One way to avoid costly fees and a low rate of return is to invest in Exchange Traded Funds (ETFs) that replicate and track a stock index. The S&P 500, for example, posted an average annual return from 1923 (the year of its inception) through 2016 of 12.25%. So, if you invested in an ETF that tracks the S&P 500, you might get far superior returns than you would from a professionally managed mutual fund.
The Debt Myth
Debt is not ideal. Being debt free should be everyone’s goal. Not having to pay monthly payments and interest charges can free up disposable income. That said, just because you still have some debt does not mean you are unable to retire. This is especially true because not all debt is equal. Or should we say, not all debt is “equally bad.”
Credit card debt, for example, is worse than mortgage debt. With a mortgage, you have a house as an appreciating asset. The more you pay down your mortgage, the more equity you build up in the house. With a credit card, it’s all debt and no equity. Heading into retirement, you will most likely want to have credit cards, lines of credit, and other loans paid off.
If you still have a mortgage on your house, though, it’s not the end of the world. While many financial experts tell clients that all their debt needs to be eliminated before retiring, including mortgage debt, the truth is that you can still retire with a mortgage. You should just ensure that you have equity in your home so that you get a return from it if you sell.
Living entirely debt free these days is often not practical – even in retirement. It’s almost impossible to shop online, for example, without using a credit card. If you want a real gut check on this issue, consider the following. A 2018 report from the Transamerica Center for Retirement Studies found that 40% of people retire with some debt. A survey from CreditCards.com found that 25% of adult Americans expect to die with debt.
The Fixed Income Myth
The saying goes that as you get closer to retirement, more of your retirement money should be in safe places. That means fixed income vehicles such as bonds and not in more volatile equities such as stocks that are subject to the ups and downs of the market. The problem with this advice is it does not factor in the need for investment growth in retirement. The fact is that you’re still going to need your investments to grow when you’re retired. They need to at least keep pace with inflation and help ensure that you don’t run out of money.
Many people in the financial industry say that 70% of your money should be invested in conservative fixed income vehicles in retirement. In fact, there used to be a “rule of thumb” that you should subtract your age from 100 and that’s the percentage of your portfolio that should be invested in stocks. For example, if you’re 30, you should keep 70% of your portfolio in stocks. If you’re 70, you should keep 30% of your money in stocks. Again, too simplistic.
To keep pace with inflation and ensure that you don’t outlive your savings, you should aim to have 60% of your investments in stocks during retirement and 40% in fixed income. Worse case is to aim for a 50/50 split between stocks and bonds. The truth is that your investments need to keep earning interest, even when you’re no longer working. Bonds pay very low interest compared to the return that can be achieved through the stock market.