Hosted By: Wyatt Yates
Money Myth: Save 10% For Retirement
In this episode, I discuss how much you need to save and invest for retirement. How do you calculate how much you need in retirement funds? What factors impact how much you need to save and invest for retirement? What one thing should you watch out for that can drastically reduce how much you have in your retirement accounts? Listen to find out.
1) Determine Your Retirement Goal Number. Take the annual income you need in retirement and multiply it by 25 to get your goal number.
2) Figure Out How Much You Need to Contribute to Reach Your Goal. Go to this retirement calculator and enter in your current information and then change the monthly contribution amount and rate of return to see how much you need to contribute to reach your retirement goal number from Step 1.
Wyatt Yates Host 00:00 Money doesn't have to be complicated. You can achieve financial independence. This podcast gets to the truth behind the money mess you hear from your grandma, your broke uncle, the latest social media influencers and the so-called money experts. Welcome to Money Myths with your host, wyatt Yates. This week's myth is save 10% for retirement and you'll be set. So this is a long-held rule of thumb amongst financial professionals or you'll see it a lot in any type of personal finance article or suggestions related to retirement Save 10% of your income and you'll be set. Now this can be true depending on when you start saving and what your retirement needs are going to be when you reach retirement age. So the earlier you start, the less you're going to have to save overall because of compounded earnings. So we talked about in the previous episode. In episode one, we went in detail on compounded earnings. So go back to that and listen to that episode if you haven't listened to it. So the compounded earnings when you start earlier are going to help you and this 10% figure might actually be okay. And the sad thing is, if you did contribute 10% of your income towards retirement, you're actually putting way more away than the average person. 01:34 One stat that's gotten a lot of publicity this last year especially during the pandemic with COVID and all of the stimulus money the government's been giving is. You've heard a lot about people's personal savings rates are near all-time highs in the US and people are saving more money, and that's a stat that the Fed tracks and actually publishes every month, and there's a big flaw in how they look at the personal savings rate though. So the personal savings rate you hear right now it's been fluctuating between 9, 11% average about 10% in personal savings rate that the Fed releases, and this isn't the 10% I'm talking about in this myth. The 10% I'm talking about in this myth is 10% of your gross income. The personal savings rate that the Fed tracks actually is your savings as a percentage of your disposable income, so it's your income after you've paid taxes and after you've spent money for housing and food and shelter and clothing and all of that stuff. So it's not comparable figures. When we're looking at these two, if you really wanted to have them be apples to apples, you'd probably need to at least double or cut in half what the personal savings rate is. So if the Fed says the personal savings rates 10% for this month, really cut it in half, and that's what really what people are saving on their gross income, which is what this myth is looking at, which is so if you say people are only putting away 5%, you can see why there's a lot of people with some issues with the retirement accounts and why retirement savings is so minimal and people are going to have a hard time coming up with the income they need in their retirement years if they're only putting away 5%. But now let's look at why this 10% rule, or myth, may not be applicable. And is it more or is it less? What do you need to do? 03:37 First, one of the biggest issues I have with this myth is you're still paying everybody else more than you're paying yourself. So Go back to episode five and episode five I covered the 50 30 20 budgeting rule and in that I talked about how much you are paying in taxes. So the average median household in the US is paying close to 40% of their income In taxes, whether that be state income taxes, federal income taxes, property taxes, fight taxes, social Security, medicare or sales tax, real estate taxes. All of the taxes people are paying for the average household is really close to 40%. So you're paying the government 40% and you're paying yourself 10%, and I went into a lot of detail with this in episode five, so you can go back to that. So that's one of the biggest concerns I have. 04:32 Your goal should always be to pay yourself the most out of everybody you're paying. You're paying yourself more than you're paying your creditors. You're paying yourself more than you're paying all of the other companies you're buying their products and services from. You're paying yourself more than what you're paying the government in taxes. That's your end goal and what you should strive for. Depending on what season you're in, that may not be achievable right now, but that's what the ultimate objective is and that's what real wealthy people are going to be doing. Real wealthy people and rich people pay themselves more than what they pay anybody else, and it can be done. You can do this If you follow proper steps and you make sure you are staying out of debt and that you're spending less than what you make and you actually make it a priority to pay yourself. 05:26 Now, the second reason why you can't necessarily rely on this 10% rule of thumb is what you need to save and invest for retirement is dependent upon A few different factors, and these factors are going to affect whether you need to save more or save less. So let's just start by first going over the three factors that affect how much you're going to have to contribute to be able to retire, and then I'll dive into each point and give a little more context and detail. So the first thing that affects how much you're going to have to save for retirement is going to be when you actually start saving for retirement. And then the second factor is going to be what are your needs during retirement? How much income are you going to need during your retirement? And then the third factor is what's the return on the investments in your retirement accounts? How much money are your investments making for you? So those are the three factors that impact how much you need to save for retirement. 06:31 So let's dive into the first point when you start. So the earlier you start to contribute into your retirement savings, the less you're going to have to contribute, and the later you start, the more money you're going to have to contribute. And this is impacted by what we went over in the previous episode, episode 21, the compounded earnings. So if you start earlier, you're going to be having to do less. If you start later, you're going to have to do more. So just think of it that way. So when you start impacts how much you're going to have to do. 07:05 Now for the second point what are your retirement income needs? So if you're going to need more income, you're going to need a bigger retirement nest egg. If you need less income in retirement years, then you obviously need less of a retirement nest egg. So you first have to try to figure out what is my income need going to be in retirement and you come up with that figure. So it's probably not going to be the same level that you have now, because you're not going to be paying taxes on a lot of your income in retirement If you were smart about how you saved and you used proper retirement vehicles, because there's a lot of tax advantages to some of these retirement accounts and you should have your mortgage paid off by the time you retire, so you're not going to have that big mortgage payment. Now, if you're wanting to do a lot more traveling, maybe you need more of an income because you're going to be spending a lot more on traveling. It really is going to depend on the individual or the couple, on what your dream retirement is, what you want your retirement to be like. So you're going to first figure out what that annual income is that you need. Ok, so that's your first step. Once you have that number, we're going to use what they call the 4% rule to calculate what that retirement number is that you need. 08:32 Now this 4% rule is a great rule of thumb and it originates from research done by a financial planner in 1994. And he looked at the 50 year period from 1926 to 1976 to try to determine what's a safe amount of your retirement funds you can withdraw and still have retirement funds left over after 30 years of withdrawals. And he determined under the worst case scenario, if you withdrew 4% of your retirement funds, you want to exhaust all of your money after 30 years. And it's been looked at several different ways and different people trying to see is it still hold true. And it continues to hold up. And sometimes they even say you can withdraw more. You know upwards of 4.5%, 5%, but so let's just use the 4%. 09:25 So if I can take 4% of my retirement funds in year one of retirement and know that I have at least 30 years of funds, then if I do, the inverse of that is 25. So 25 times what my income level I need is going to give me my retirement balance that I want to have and my goal to have in my retirement accounts when I go to retire. So say, my income that I want per year in retirement is $50,000 a year. I multiply that by 25, I'm going to get $1.25 million. So my goal balance then would be $1.25 million. So now that I have what I think I need for my retirement goal balance, I can then go to basically about any retirement calculator out there and put in my current age and all of that what I currently have saved, to try to calculate what am I going to need to save every month to reach that retirement goal balance? Chances are it's probably going to be higher than 10% for most people. For most people you're going to need probably 15%, 20% so when you're starting, but you're probably going to need more than the 10% in this rule. 10:51 Now the third factor that really affects what you need to save for retirement is how much your retirement investments are making and earnings, and this is an area that can drastically impact what you need to contribute. So I just want to go through an example of just a couple percentage points difference in returns and how that impacts what you would have in retirement. So let's say we have a 37 year old individual that's going to contribute $500 a month from now until age 67. So for 30 years they're going to contribute $500 a month. Over that 30 year period they've contributed in to retirement $192,000. Let's say during that 30 year period their retirement account earned a 7% annual return after fees At the end of those 30 years. So in year one of retirement they would have $714,000. So their $192,000 earned $522,000 over those 30 years. That's with a 7% return, you have $714,000. But let's say this person, instead of earning 7%, they earned 9%. So 2% better in return and annual returns. Instead of having $714,000, they would have $1.1 million and would have $916,000 in earnings. So almost $400,000 more in earnings over the 30 year period. So almost double. So 80% more than the 7% return. So just having a 2% better rate of return drastically impacts how much you're going to have in retirement. Let's take it one step further and look at if you, instead of getting 7%, we got an 11% return. So if you had an 11% annual return over those 30 years, you'd have $1.8 million. So the difference between an 11% return and a 7% return is $1.1 million. So a 4% better rate of return Generated way more than double the balance in year one retirement. So this person would have $714,000 if they got a 7% return Versus 11% return, they'd have $1.8 million dollars big difference. And that's why it's really important that You're maximizing your returns in your retirement accounts because it's gonna drastically impact how much you're gonna have to contribute in. 13:40 One area where a lot of people get eaten up in this are the fees on their investments. Fees make a big difference in your net rate of return, and by net I mean what's my return after fees. So mutual funds, which are great diversification investment strategy, mutual funds have wide-ranging fees. You can have anywhere from 0.25%. So quarter of 1% to 2% of your investment is fees, and we just went over how much 2% Difference in rate of return impacts your retirement account. So fees amongst your investments and what you're invested in Need to be watched and you really need to pay close attention. So you'll hear the argument Well, it has higher fees because it's professionally managed and it's gonna get a better rate of return Gross. So even net of fees, I'm still better off and that's just more than likely not the case. 14:51 So there's a couple examples of this. One example is in 2008 Warren Buffett. So everybody knows Warren Buffett, the Oracle of Omaha, one of the richest people in the world, and he's famous for being a really savvy investor. He's made his money in the in the stock market, investing in companies. So in 2008, he put out a challenge to hedge fund managers, which hedge funds have some of the highest fee structures and he put out a challenge that he would bet do a million dollar bet with any hedge fund manager that they couldn't outperform an Index fund, so the overall stock market over a ten-year period. And his Rational was that these hedge funds, net of their fees, can outperform the market over a ten-year period, and it's very hard to outperform the overall stock market. So how many of these Hedge fund managers that think they're smarter than the overall market and can outperform it? And you know, one of the ways they get all their money is to tell people that you know they're Smart and they can Give them a better return. So give me your money, I can get you a better return. Well, only one hedge fund manager actually took Warren up on his bet million dollar bet and he lost. So the hedge fund Guy that took up the bet Did not outperform the market over the ten-year period and he lost the million dollar bet with Warren. 16:32 And another thing you can look at is that S&P and Dow Jones indices publish the semi annual reports called the S&P indices verse active. So they're looking at these index funds, which are a recent thing. You know 30, 40 years ago you don't have these index funds and these index funds track the overall stock market. So these semi annual reports come out twice a year and it's basically the same thing every six months where, looking over a 15-year period, nearly 90% of actively managed investment funds fail to beat the overall stock market and these index funds. So these actively managed funds that charge upwards of 2% Can't beat the market. And guess what? These index funds? They average a fee of 0.06%, so 6 100 of a percent, so 33 times less than what some of these actively managed funds charge, and fees that their gross return isn't even equal in what the index funds gross return is. So that's why these index funds have become so popular. 17:51 Or these ETFs you may hear ETFs in the news, that just stands for exchange traded funds and these index mutual funds and ETF funds charge significantly less in fees than these actively managed funds and 90 percent of the time they're outperforming those funds that are charging way more in fees, and these fees are costing you hundreds and hundreds of thousands of dollars, maybe even millions of dollars, depending on what you're putting into your retirement and what you would have at the end of retirement. So that's why you want to really be cognizant of the fee structure in your investments that are in your retirement account. So if you're invested in mutual funds or index mutual funds or ETFs, you always want to look at the fees and make sure you're not paying absorbent fees, because it's really going to hurt you when you reach retirement with how much money you're going to have in your account, and then that affects how much you can pull out every year in income off of those accounts. So really watch the fees. So let's summarize this and then get to your action step. 19:04 How can you apply this? So the myth is save 10 percent of your income for retirement and then you'll be set. You're going to have enough in retirement funds to be able to retire. That is the myth and it's a long held belief and rule of thumb that finance professionals have thrown out there and it's a much larger number than your typical person is saving for retirement. So it maybe seems reasonable because maybe now you're only doing 5 percent because that's all your employer will match, or or, with my 5 percent, my employer matches five. So then that's my 10 percent, so I'm good, but it's very likely that 10 percent is not going to be enough for you. For the typical person, 10 percent will not be enough unless you start super early and your income needs and retirement are very low. 10 percent will not be enough. And by only doing 10 percent, you're saying you're okay with paying everybody else more than what you're paying yourself. 20:13 Such, if you want true wealth and you want to reach financial independence, you have to get to the goal and have the mindset of. My goal is going to be to get to where I can pay myself more than I'm paying anybody else, whether that be the government, whether that be my creditors, whether that be the companies I'm buying goods and service from. If I want true wealth and true financial independence, I want to be paying myself more of my income than anybody else. And then you have to look at what impacts your retirement account and your retirement needs. So you got to look at when am I starting to save and invest for retirement? The later I start, the more I'm going to have to do, and it may be 15, 20, it may be 30, 40 percent of my income I have to contribute, depending on if I'm starting super late. So the earlier I start, the less I'm going to have to contribute. And then I have to understand what am I going to need an income in retirement? And then I can use the rule of thumb of 4 percent the 4 percent rule and multiply that annual income by 25 to get my need, and that's going to give me a target to go after. And then you got to be really focused on what are your annual rates of return? What am I earning on my investments? And one of the biggest and easiest ways to boost your returns is to really focus on the fee structure of the investments that you're invested in and making sure that you're minimizing those as much as you can. And a good way to do that is to invest in index funds or ETFs, things that have low fee loads, that aren't going to be charging one and a half two percent fee structure. 22:09 Now let's dive into the action steps. How can we apply this. So the first thing I want you to do is we're going to calculate our retirement goal number. So you're going to come up with what you think you need in income and retirement and you're going to take that number, whether it's 50,000, 100,000 a year. You're going to take that number and you're going to multiply it by 25. And that's going to give you your retirement goal. And then you're going to go to a retirement calculator online and I'll include a link in the show notes To one that you can use. I really like nerd wallets or Ramsey solutions. They both have good calculators, but I'll include one in the notes. 22:51 So you take that retirement gold number and You're going to go to this retirement calculator and in the retirement calculator You're going to put in your current age, the current amount that you have saved, what your current income is, and then you're going to play around with the what you need to contribute to see what you have to contribute to hit that Retirement gold number. And that's going to give you a target on what I need to be putting away every month To be able to do it. And chances are I bet it's way higher than 10%. So let's just say you had a hundred thousand dollar Income need you need two and a half million dollars in your retirement account. You're in, say, you're starting at age 40. You're gonna have to do a lot more than 10% of your income to get to that two and a half million. 23:36 So Another thing that you can play around with on the retirement calculator is rate of returns. I like to be conservative on this Estimate so I would definitely use, you know, on the very high end, maybe 10%, but I would like to you you to use probably like a 7 8% rate of return for net of fees, because it's gonna be a conservative approach. Say you do better, you'll have a lot more and then you'll be fine. But If you really over estimate what your rate of return is gonna be, you're gonna be getting 10 years out from retirement and Be playing big-time catch up because your investments probably didn't hit it. So I just like to be really conservative on what we think the rate of return may be. So somewhere between that seven, eight, maybe nine percent you could use To try to figure out what you need to contribute each month. So calculate your retirement goal number by multiplying your annual income that you need in retirement by 25. Then go to that retirement calculator, put in the figures and play around with that monthly contribution to see what you need to put in to retirement to hit your goal number and Chances are it's probably more than 10%, unless you were good and you started really early. But this will kind of hopefully open your eyes and give you a sense of urgency on making this a priority and getting your financial house in order and making it in a priority. 25:04 Thanks for listening. Want to achieve financial independence? Go to ruggedfinancialcom where you can download a free PDF of the 12 things to do to win with money, and you can also sign up for my weekly money tips emails where I cover the same tips and tricks and advice I walk all my clients through so you can begin your journey to financial independence. Thank you for watching and listening to this episode of the money myths podcast. 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