MONEY retirement planning

3 Ways to Build a $1 Million Nest Egg Despite Lower Investment Returns

Andy Roberts/Getty Images

Whether your retirement goal is six figures or seven figures, it's harder to achieve in today's market—unless you have a plan.

A new Transamerica Center for Retirement Studies survey found that $1 million is the median savings balance people estimate they’ll need for retirement. And many savers have been able to reach or exceed that goal, according a report last year by the Government Accountability Office showing that some 630,000 IRA account owners have balances greater than $1 million.

But most of these people accumulated those hefty sums in an era of generous investment returns. Between 1926 and 2014, large-company stocks gained an annualized 10.1%, while intermediate-term government bond returned 5.3% annually, according to the 2015 Ibbotson Classic Yearbook. During the go-go ’90s annualized gains were even higher—18.2% for stocks and 7.2% for bonds. Today, however, forecasts like the one from ETF guru Rick Ferri call for much lower gains, say, 7% annualized for stocks and 4% or so for bonds. Which makes building a seven-figure nest egg more of a challenge.

Still, the goal remains doable, if you go about it the right way. Here are three steps that can increase your chances of pulling it off.

1. Get in the game as early as possible—and stay in as long as you can. The more years you save and invest for retirement, the better your chances of building a big nest egg. Here’s an example. If you’re 25, earn $40,000 a year, receive annual raises of 2% during your career and earn 5% a year after expenses on your savings—a not-too-ambitious return for a diversified portfolio of stocks and bonds—you can accumulate a $1 million account balance by age 65 by saving a bit more than 15% of salary each year. That’s pretty much in line with the recommendation in the Boston College Center For Retirement Research’s “How Much Should People Save?” study.

Procrastinate even a bit, however, and it becomes much tougher to hit seven figures. Start at 30 instead of 25, and the annual savings burden jumps to nearly 20%, a much more challenging figure. Hold off until age 35, and you’ve got to sock away more a far more daunting 24% a year.

Of course, for a variety of reasons many of us don’t get as early a start as we’d like. In that case, you may be able to mitigate the savings task somewhat by tacking on extra years of saving and investing at the other end by postponing retirement. For example, if our hypothetical 25-year-old puts off saving until age 40, he’d have to sock away more than 30% a year to retire at 65 with $1 million. That would require a heroic saving effort. But if he saved and invested another five years instead of retiring, he could hit the $1 million mark by socking away about 22% annually—still daunting, yes, but not nearly as much as 30%. What’s more, even if he fell short of $1 million, those extra years of work would significantly boost his Social Security benefit and he could safely draw more money from his nest egg since it wouldn’t have to last as long.

2. Leverage every saving advantage you can. The most obvious way to do this is to make the most of employer matching funds, assuming your 401(k) offers them, as most do. Although many plans are more generous, the most common matching formula is 50 cents per dollar contributed up to 6% of pay for a 3% maximum match. That would bring the required savings figure to get to $1 million by 65 down a manageable 16% or so for our fictive 25-year-old, even if he delayed saving a cent until age 30. Alas, a new Financial Engines report finds that the typical 401(k) participant misses out on $1,336 in matching funds each year.

There are plenty of other ways to bulk up your nest egg. Even if you’re covered by a 401(k) or other retirement plan, chances are you’re also eligible to contribute to some type of IRA. (See Morningstar’s IRA calculator.) Ideally, you’ll shoot for the maximum ($5,500 this year; $6,500 if you’re 50 or older), but even smaller amounts can add up. For example, invest $3,000 a year between the ages of 25 and 50 and you’ll have just over $312,000 at 65 even if you never throw in another cent, assuming a 5% annual return.

If you’ve maxed out contributions to tax-advantaged accounts like 401(k)s and IRAs, you can boost after-tax returns in taxable accounts by focusing on tax-efficient investments, such as index funds, ETFs and tax-managed funds, that minimize the portion of your return that goes to the IRS. Clicking on the “Tax” tab in any fund’s Morningstar page will show you how much of its return a fund gives up to taxes; this Morningstar article offers three different tax-efficient portfolios for retirement savers.

3. Pare investment costs to the bone. You can’t force the financial markets to deliver a higher rate of return, but you can keep more of whatever return the market delivers by sticking to low-cost investing options like broad-based index funds and ETFs. According to a recent Morningstar fee study, the average asset-weighted expense ratio for index funds and ETFs was roughly 0.20% compared with 0.80% for actively managed mutual funds. While there’s no assurance that every dollar you save in expenses equals an extra dollar of return, low-expense funds to tend to outperform their high-expense counterparts.

So, for example, if instead of paying 1% a year in investment expenses, the 25-year-old in the example above pays 0.25%—which is doable with a portfolio of index funds and ETFs—that could boost his annual return from 5% to 5.75%, in which case he’d need to save just 13% of pay instead of 15% to build a $1 million nest egg by age 65, if he starts saving at age 25—or just under 22% instead of 24%, if he procrastinates for 10 years. In short, parting investment expenses is the equivalent of saving a higher percentage of pay without actually having to reduce what you spend.

People can disagree about whether $1 million is a legitimate target. Clearly, many retirees will need less, others will require more. But whether you’ve set $1 million as a target or you just want to build the largest nest egg you can, following the three guidelines will increase your chances of achieving your goal, and improve your prospects for a secure retirement.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY Social Security

How to Choose the Social Security Claiming Age That’s Right for You

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More people are catching on to the benefits of delaying Social Security. But the real issue isn't when everyone else claims—it's finding the strategy that fits your goals.

Retirement experts have been pounding the drums for years about deferring Social Security benefits and allowing them to grow until claimed at age 66 or even as late as 70. Yet average retirement ages have moved little—most people continue to file at or near age 62, the earliest that standard retirement benefits can be claimed, Social Security data show.

Now, thanks to some new research by the Center for Retirement Research at Boston College, this puzzling contradiction has been solved. It turns out that people are aware of the benefits of delayed filing and, in fact, have been claiming later for many years.

Why the discrepancy in these numbers? In its analysis, Social Security looks at when people file for retirement benefits and does a year-by-year calculation of average claiming ages. This approach works fine during periods of stable population growth, but not so much today.

Social Security’s method fails to account for the soaring numbers of Baby Boomers reaching retirement age. For example, nearly 900,000 men turned 62 in the year 1997, while in 2013, roughly 1.4 million men did so. Even so, a smaller percentage of 62-year-old men filed for Social Security in 2013 than in earlier years. But because the number of 62-year-old retirees make up such a big share of all claims, the average age has remained largely unchanged.

To get a better picture of claiming trends, the Center also used a lifecycle analysis. Instead of tracking the ages of everyone who began benefits in a certain year, such as 2013, it calculated the claiming ages of everyone by the year in which they were born. Looking at this so-called “cohort” data, it became clear that average claiming ages actually had increased far more than people thought.

In 2013, for example, 42% of men and nearly 48% who claimed that year were 62 years old. But only 36% of men and nearly 40% of women who turned 62 in 2013 actually filed for Social Security. “The cohort data reveal that the claiming picture has really changed,” the Center said.

I am cheered by these new findings. People should consider deferring their Social Security benefits and see how doing so would affect their retirement plan. But the key word in that sentence is “plan.” You need one, and it should include figuring out the best Social Security strategy for you, not what’s best for other retirees. Here are the steps to get there:

  • Compare the tax benefits. Our hearts tell us that preserving 401(k) dollars in our nest eggs is essential. But when it comes to spending down those assets in order to delay claiming Social Security, the deferral strategy looks very good. Between the ages of 62 and 70, Social Security retirement benefits rise 7% to 8% a year. They are adjusted upward each year to account for inflation. They are guaranteed by Uncle Sam. Federal taxes are never levied on more than 85 cents of each dollar of Social Security benefits, and most states don’t tax them at all. Compare these terms with 401(k) gains and taxation, and then decide which dollars are most worth preserving.
  • Assess the cost of early claiming. Social Security benefits claimed before Full Retirement Age (66 for people now nearing retirement) are hit with early claiming reductions and, if you are still working, subject to at least temporary benefit reductions caused by the Earnings Test.
  • Weigh the Medicare impact. If you have a health savings account (HSA) through employer group insurance and are eligible for Medicare, filing for Social Security will force you to take Part A of Medicare. It’s normally free but the consequences are not: the filing will force you to drop out of your HSA.
  • Consider longevity risk. Review your family health history, complete an online longevity survey, and estimate your probable lifespan. What does this number say about how long your retirement funds need to last and when you should begin taking Social Security?
  • Think about your family. Will you still have school-age children at home when you turn 62? If so, filing early for Social Security may allow your kids to claim benefits based on your earnings record. This is one case when filing early may put more money in your pocket.
  • Plan for your spouse. Survivor’s benefits are keyed to the Social Security benefits received by the deceased spouse. So, the longer a spouse waits to claim, the higher their partner’s survivor benefit will be. This is a real issue for millions of women who survive their husbands and whose own retirement benefits are smaller than their husbands because they have earned less money in their lives.

Philip Moeller is an expert on retirement, aging, and health. He is co-author of The New York Times bestseller, “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” and is working on a companion book about Medicare. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: How the Social Security Earnings Test Could Wipe Out Your Income

MONEY retirement planning

This Popular Financial Advice Could Ruin Your Retirement

two tombstones, one saying $-RIP
iStock

The notion of "dying broke" continues to appeal to many Americans. That's too bad, since the strategy is ridiculously flawed.

You may have heard of the phrase “Die Broke,” made popular by the bestselling personal finance book of the same name published in 1997. The authors, Stephen M. Pollan and Mark Levine, argue that you should basically spend every penny of your wealth because “creating and maintaining an estate does nothing but damage the person doing the hoarding.” Saving is a fool’s game, they claim, while “dying broke offers you a way out of your current misery and into a place of joy and happiness.”

I love a good contrarian argument, but for whom did this plan ever make sense? Perhaps people like Bill Gates who have so much money that they decide to find charitable uses for their vast fortune. But for the rest of us, our end-of-life financial situation isn’t as nearly pretty, and we’re more likely to be in danger of falling short than dying with way too much.

In a recent survey, the Employee Benefit Research Institute found that 20.6% of people who died at ages 85 or older had no non-housing assets and 12.2% had no assets left at all when they passed away. If you are single, your chances of running out of money are even higher—24.6% of those who died at 85 or older had no non-housing assets left and 16.7% had nothing left at all.

Now, perhaps some of those people managed to time their demise perfectly to coincide when their bank balance reached zero, but it’s more likely that many of them ran out of money before they died, perhaps many years before.

And yet the “Die Broke” philosophy seems to have made significant headway in our culture. According to a 2015 HSBC survey of 16,000 people in 15 countries, 30% of American male retirees plan to “spend it all” rather than pass wealth down to future generations. (Interestingly, only 17% of women said that they planned to die broke.)

In terms of balancing spending versus saving, only 61% of men said that it is better to spend some money and save some to pass along, compared to 74% of women. Perhaps that’s why, as a nation, only 59% of working age Americans expect to leave an inheritance, compared to a global average of 74%.

There are so many things wrong with this picture. The first is that Pollan and Levine’s formula of spending for the rest of your life was predicated on working for the rest of your life. “In this new age, retirement is not only not worth striving for, it’s impossible for most and something you should do you best to avoid,” they wrote. Saving for retirement is certainly hard, and I don’t believe that all gratification should be delayed, but working just to spend keeps you on the treadmill in perpetuity.

Besides, even if some of us say we’re going to keep working all our lives, that decision is usually dictated by our employer, our health and the economy. Most of us won’t have the choice to work forever, and the data simply don’t support a huge wave of people delaying retirement into their 70s and 80s. And as I have written before, I don’t buy into the current conventional wisdom that planning for a real retirement is irrational.

But perhaps the most pernicious aspect of the “Die Broke” philosophy is that it takes away the incentive to our working life—to get up in the morning and do your best every day, knowing that it’s getting you closer to financial security—and the satisfaction that goes with it. In the end, I believe what will bring us the most happiness is not to die rich, or die broke, but to die secure.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.

Read next: This Retirement Saving Mistake Could Cost You $43,000

MONEY retirement planning

The 5 Best Free Online Retirement Calculators

Calculator
Charlie Surbey—Gallery Stock

To be sure you'll reach your retirement goals, you've got to run some numbers. These 5 tools can help you get started.

If you want to be serious about retirement, you’ve got to crunch some numbers. Otherwise, you can’t really tell amidst the ups and downs of the economy and the market whether you’re on track toward an acceptable post-career lifestyle. These five tools, all free, can help improve your planning and your prospects. You’ll find links to all five in RDR’s Retirement Toolbox.

1. Retirement Income Calculator This T. Rowe Price tool allows you to provide detailed information about your finances—how your savings are invested, pension and Social Security payments, income from part-time work, if any, etc.—so you can come away with a nuanced sense of your retirement readiness. Once you know where you stand, you can then run alternative scenarios to see how you might improve your prospects. If you’ve already retired, this tool will help you determine whether your current level of spending is sustainable throughout retirement or whether you need to tighten your belt.

Rather than estimating the size nest egg you’ll need in retirement as many calculators do, this tool focuses on sustainable income. Specifically, you enter the amount of income you expect you’ll need in retirement (say, 80% of pre-retirement salary) and the tool uses Monte Carlo simulations to estimate the likelihood that the resources you’re projected to accumulate (or have already accumulated if you’re retired) will generate sufficient income throughout retirement. Generally, you want to see a success rate of at least 80%. If you fall short of that level, you can see how changing different aspects of your finances—saving more, spending less, cutting investment fees, etc.—might improve your chances of success. Revving up this calculator every year or so and making small tweaks as needed can prevent you from falling behind in your planning and help you avoid having to make dramatic and painful adjustments to your lifestyle later in life.

2. Risk Questionnaire—Allocation Tool One of the most important aspects of setting an investing strategy is choosing a stocks-bonds mix that jibes with your appetite for risk. Invest too aggressively, and you may end up selling stocks in a panic when the market dives. Invest too conservatively, and you may not earn the returns you need to achieve your goals. This questionnaire from Vanguard can guide you to an appropriate stocks-bonds allocation. Just answer 11 questions designed to probe, among other things, your investing habits and how you might react to major market setbacks, and you’ll receive a suggested mix of stocks and bonds (and, in some cases, cash). Click on the “other allocations link,” and you’ll get stats showing how your recommended portfolio as well as ones more aggressive and conservative have performed on average and in good and bad markets since 1926.

3. Retirement Income Planner (and Retirement Budget Worksheet) Estimating that you’ll need 80% or so your pre-retirement income after you retire may be okay for establishing a savings target during your career. But once you’re within 10 or so years of retiring, you want to get a better handle on what your actual retirement expenses might be. This interactive retirement budget sheet, which you’ll find within Fidelity’s Retirement Income Planner tool, will help you do just that. It not only has slots for 49 different expense items, ranging from cable and internet fees to health care and travel; it also allows you to check a box next to each expense designating whether it’s essential. The tool then provides a tally of all your expenses, plus a breakdown of essential vs discretionary ones. This can give you a sense of how much wiggle room you have to pare expenses if necessary, plus show you which areas are prime candidates for cuts. Of course, no level of detail will be able to sure 100% accuracy. But that’s not the goal. The point is to make the best estimate you can and then refine your budget (and your actual spending) as needed as you go along.

4. Financial Engines’ Social Security Calculator One of the single most important decisions retirees face is when to claim Social Security. Unfortunately, many retirees don’t give this issue the serious thought it deserves, and just take benefits as soon as they can (age 62) or soon thereafter. That can be a costly mistake. Each year you postpone benefits between age 62 and 70, your payment increases about 7% to 8%, dramatically boosting the amount you may collect during your lifetime. By taking advantage of a number of different claiming strategies, married couples may be able to boost their potential lifetime benefit several hundred thousand dollars.

Which is why in the years leading up to retirement, it’s a good idea to check out Financial Engines’ Social Security calculator. You just enter such information as your age, current income, the age at which you expect to begin collecting Social Security. The tool will then estimate the amount you’ll collect in today’s dollars over your lifetime if you claim benefits as planned—and show how much more you might collect by claiming at a different age. If you’re married, the tool will show how you and your spouse might maximize lifetime benefits by better coordinating when each of you claims. Another nifty feature: you can see how the projections changed depending on whether your life expectancy exceeds or falls short of average.

While this tool is a good way to start thinking about how and when you might claim Social Security benefits, the amount of money at stake is large enough that you may want to hire an adviser to help you with this decision or go to a Social Security claiming service, such as Maximize My Social Security or Social Security Solutions, that, for a fee, will help you devise a strategy.

5. Will You Have Enough To Retire? I know that no matter what I or anyone else says, some people simply aren’t going to spend more than a minute with any tool. If you’re one of those people—or you just want a quick update to see if you’re on the path to a secure retirement—this tool is for you.

Just enter your age, the age you expect to exit your job, the amount, if any, you have saved so far, the percentage of income you’re saving each year and the tool will immediately estimate the amount you’ll need at retirement and the amount you’re projected to have. At a glance, you can quickly see whether you’re likely to have an adequate nest egg if you continue on your current path. If it appears you’re falling short, you can see how your chances improve by, say, saving a higher percentage of pay or delaying retirement a few years (or both). My only gripe about this tool: I wish it couched its estimates in sustainable annual income in retirement rather than giving you your retirement “number.”

Are there other worthwhile free tools that can help you better plan for retirement? Sure, you’ll find at least a dozen more listed in RDR’s Retirement Toolbox, including one that will show you how much guaranteed lifetime income a specific sum of savings might generate, another that can help you decide between a traditional and Roth IRA and one that can help you compare the cost of living in different cities.

But to create an overall retirement strategy and monitor it to make sure you stay on track, you can start with these five.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY Ask the Expert

How to Save For Retirement When You Don’t Have a 401(k)

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: The company I work for doesn’t offer a 401(k). I am young professional who wants to start saving for retirement but I don’t have a lot of money. Where should I start? – Abraham Weiser, New York City

A: Millions of workers are in the same boat. One-quarter of full-time employees are at companies that don’t offer a retirement plan, according to government data. The situation is most common at small firms: Only 50% of workers at companies with fewer than 100 employees have 401(k)s vs. 82% of workers at medium and large companies.

Certainly, 401(k)s are one of the best ways to save for retirement. These plans let you make contributions directly from your paycheck, and you can put away a large amount ($18,000 in 2015 for those 49 and younger), which can grow tax sheltered.

But there are retirement savings options beyond the 401(k) that also offer attractive tax benefits, says Ryan P. Tuttle, a certified financial planner at Connecticut Wealth Management in Farmington, Ct.

Since you’re just getting started, your first step is to get a handle on your spending and cash flow, which will help you determine how much you can really afford to put away for retirement. If you have a lot of high-rate debt—say, student loans or credit cards—you should also be paying that down. But if you have to divert cash to pay off loans, you won’t be able to put away a lot for savings.

That doesn’t mean you should wait to put money away for retirement. Even if you can only save a small amount, perhaps $50 or $100 a week, do it now. The earlier you get going, the more time that money will have to compound, so even a few dollars here or there can make a big difference in two or three decades.

You can give an even bigger boost to your savings by opting for a tax-sheltered savings plan like an Individual Retirement Account (IRA), which protects your gains from Uncle Sam, at least temporarily.

These come in two flavors: traditional IRAs and Roth IRAs. In a traditional IRA, you pay taxes when you withdraw the money in retirement. Depending on your income, you may also qualify for a tax deduction on your IRA contribution. With a Roth IRA, it’s the opposite. You put in money after paying taxes but you can withdraw it tax free once you retire.

The downside to IRAs is that you can only stash $5,500 away each year, for those 49 and younger. And to make a full contribution to a Roth, your modified adjusted gross income must be less than $131,000 a year if you’re single or $193,000 for those married filing jointly.

If your pay doesn’t exceed the income limit, a Roth IRA is your best option, says Tuttle. When you’re young and your income is low, your tax rate will be lower. So the upfront tax break you get with a traditional IRA isn’t as big of a deal.

Ideally, you’ll contribute the maximum $5,500 to your IRA. But if you don’t have a chunk of money like that, have funds regularly transferred from your bank account to an IRA until you reach the $5,500. You can set up an IRA account easily with a low-fee provider such as Vanguard, Fidelity or T. Rowe Price.

Choose low-cost investments such as index funds and exchange-traded funds (ETFs); you can find choices on our Money 50 list of recommended funds and ETFs. Most younger investors will do best with a heavier concentration in stocks than bonds, since you’ll want growth and you have time to ride out market downturns. Still, your asset allocation should be geared to your individual risk tolerance.

If you end up maxing out your IRA, you can stash more money in a taxable account. Look for tax-efficient investments that generate little or no taxable gains—index funds and ETFs, again, may fill the bill.

Getting an early start in retirement savings is smart. But you should also be investing in your human capital. That means continuing to get education and adding to your skills so your earnings rise over time. Your earnings grow most quickly in those first decades of your career. “The more you earn, the more you can put away for retirement,” says Tuttle. As you move on to better opportunities—with any luck—you’ll land at a company that offers a great 401(k) plan, too.

Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.

Read next: Quick Guide to How Much You Need to Retire

MONEY 401(k)s

This Retirement Saving Mistake Could Cost You $43,000

piggy bank split in half (half pink, half red)
Levi Brown—Trunk Archive

Nothing is free when it comes to investing, but your 401(k) match comes close. Here's how to get the most from it.

People are panicked about having enough money for retirement. Yet millions of workers are leaving thousands of dollars on the table every year because they’re not doing one thing: Contributing enough to receive a full employer matching contribution to their 401(k).

Some 98% of employers with a 401(k) offer some kind of match, according to AonHewitt. Typically, employers contribute a dollar for each dollar you save in your 401(k), up to 6% of your salary. Other 401(k) surveys show that matching 50¢ for each dollar you contribute is more common.

Whatever the match level, it’s free money. And one in four workers miss out on getting the full amount because they’re not saving enough, according to a new research report by Financial Engines, which provides financial advisory services to 401(k) plans.

For the average worker, that means forgoing $1,336 a year or an extra 2.4% of annual income, assuming a dollar for dollar match. Over time with compounding, you could be missing out on as much as $42,855 over 20 years. All told, U.S. workers are passing up about $24 billion a year in matching contributions, according to Financial Engines.

By not taking full advantage of the match, workers are giving up an immediate guaranteed return for every dollar they invest, Financial Engines’ director of financial technology Greg Stein noted in the study.

The people most likely to miss out are the ones who need it the most: Younger workers and those with lower incomes. Among people with 401(k)s who earn less than $40,000 a year, 42% don’t save enough to get the full match, compared with just 10% of workers earning more than $100,000 a year. Workers younger than 30 are twice as likely not to earn a match compared with workers over age 60, 30% vs. 16%.

Though retirement contributions generally increase with age, those amounts tend to flatten out between ages 35 and 45, according to the report. That’s not surprising since that’s the time period when many households incur big-ticket expenses, such as buying a house and raising kids.

If boosting your 401(k) savings rate feels like a stretch, here’s a simple strategy: Increase the amount you contribute gradually, by just 1% a year—perhaps when you get a raise. Since the money comes out of your paycheck pretax, a small savings hike won’t feel like a big pinch.

Here’s an example: If you earn $50,000 a year and are in the 25% tax bracket, boosting your contribution from 3% to 6% will only reduce your weekly paycheck by $24. Over 35 years, that would add more than $320,000 to your retirement savings. Use this calculator to see impact of your retirement contributions on your paycheck.

Even if you contribute enough to get a full 401(k) match, don’t stop there. A 6% or so savings level probably isn’t enough to ensure a comfortable retirement—financial planners recommend that people save 10% to 15% of their income each year. But ensuring that you get all your free match money will make it much easier to reach your goal.

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MONEY consumer psychology

How a Bowl of Cashews Changed the Way You Save for Retirement

Matt Furman Richard Thaler

Richard Thaler pioneered behavioral economics, and changed the way companies manage their 401(k)s.

As young academic in the 1970s, the economist Richard Thaler began compiling what he calls “the List,” a collection of the everyday ways in which real people fail to act as economic theory predicts. One item on the List: the puzzling reaction of his friends at a party when Thaler took away a bowl of cashews. The List became the seed of his pioneering work in the new field of behavioral economics, a field that has, among other things, transformed how 401(k) plans are designed. (If you were automatically signed up for your company’s retirement plan, you can thank behavioral research.)

Thaler, 69, is a professor at the University of Chicago Booth School of Business. (He tweets at @R_Thaler.) His new book Misbehaving: The Making of Behavioral Economics was published on May 11. MONEY editor-at-large Penelope Wang interviewed Thaler for the June issue of the magazine. The interview, which was edited, starts with a discussion of what happened with those cashews.

How can I make smarter money choices?
It helps to have what I call nudges. The lesson of my field, behavioral economics, is that we need to understand the ways in which we differ from the rational human assumed in standard economic theory. I call this idealized person the “Econ.”

My classic example of the difference between Econs and actual humans is something that happened years ago. I was having a dinner party for fellow economics grad students. Before dinner I served some cashew nuts along with cocktails, and everyone kept eating them. Soon their appetites were in danger, not to mention their waistlines. I grabbed the bowl and hid it in the kitchen. People were (a) happy, and (b) they realized their reaction conflicted with traditional economic theory. Econs are better off with more choices. We humans actually need help controlling our impulses—nudges.

How would “hiding the cashews” work with money?
Here’s a model of saving for retirement that’s guaranteed to fail: Decide at the end of every month how much you want to save. You’ll have spent a lot of the money by then. Instead, the way to really save is to put the money away in a 401(k) even before you get it, via a payroll deduction. And behavioral economics says a little nudge can help you to do that even better.

In 1994 I wrote an article advising auto-enrollment in 401(k) plans—putting people in the plan by default, while giving them an opportunity to opt out, so you still have a choice. Saving would happen without having to make decisions to do it every week or month. The 2006 Pension Protection Act even encouraged employers to use auto-enrollment, and now more than half of large plans do so. But many people still aren’t saving enough.

In fact, you say many plans are nudging people to save too little.
Most companies using auto-enrollment set the default contribution rate too low. It’s stuck at 3% of salary, which was never intended by the law. Can you get people to save more than the default? Part of the answer is to combine auto-enrollment with auto-escalation. Research I did with Shlomo Benartzi of UCLA showed that even if people think they can save only a little right now, they’re willing to accept future increases in contributions, such as when they get raises. A state-of-the-art 401(k) should start out with auto-enrollment at 6% and escalate to at least 10% or higher. The evidence shows raising the default to 6% won’t lead to a high opt-out rate.

Money

Outside of a 401(k), how can knowing a bit about behavioral economics help me make better decisions? Psychology and economics professor George Loewenstein, at Carnegie Mellon, has a phrase: hot-cold empathy gap. It means you have two kinds of emotional states, hot and cold. So if I’m thinking about what to have for dinner in the morning, when I’m not hungry, I’ll say I’ll have fish and salad. I’m in a cold state. But by the time I go out for dinner, I’ll have a weakness maybe for a cocktail, I’ll see ribs and a big bowl of pasta—I’ll be in a hot state. I’ll order the ribs.

The point George makes is that people overestimate the self-control they’ll have in the hot state. So we need to make concessions to our frailties, such as choosing a restaurant with healthier choices or making a list before you go shopping, to help you buy only what you decided to buy in the cold state. If you’re not putting enough away for emergencies or retirement, making commitments in advance, such as signing up for payroll withholding, can help.

You helped discover something called the endowment effect. It seems like something that would affect investors. Tell us about it.
It was one of the first behaviors I studied, and it shows we demand more to give things up than we would pay to acquire them. We studied this by showing how students valued coffee mugs we handed out. People who got the mugs demanded twice as much to give them up as people who didn’t get the mugs would pay to get one. The endowment effect overlaps with other behavioral phenomena, such as loss aversion—seeking to avoid losses more than we seek gains—and a bias for the status quo. For these reasons, investors tend to hold on too long to stocks that have gone down, hoping they will rebound so they can sell without realizing a loss.

If people aren’t as rational as economists assume, can I take advantage of that as an investor?
That’s exactly what some professional investors are trying to do. Behavioral economics offers a plausible explanation for overreactions by the market. For example, a long period of bad performance can lead to stereotyping. There was a period when Apple was considered an inept company on the road to bankruptcy. That was an opportunity.

But it’s not easy to beat the market. Most professionals fail, and research shows individuals are abysmal market timers, buying high and selling low. I don’t think I can beat the market, but I think my firm can. [Thaler is a co-founder of a money management firm, Fuller & Thaler, but does not choose its investments.] I keep my money professionally managed or in index funds.

Maybe I could at least use behavioral insights to spot times when there’s an irrational bubble.
I don’t think most people can. For example, research shows people buy real estate based on naive extrapolations. “Real estate prices in Scottsdale will never go down.” I think we can make two conclusions: One, we’re really bad at this. Two, with investments like target-date funds, which diversify your assets and rebalance automatically, you can minimize the damage.

It seems so obvious that people make mistakes, but your book has gossipy fun recounting pitched academic battles over the idea. Why do economists resist it?
Some thought human errors were random and so would cancel each other out, which the work of [economics Nobel laureate] Daniel Kahneman and the late Amos Tversky found was not true. Most of the errors go in the same direction. Or they thought that if the stakes are high, people make the right decisions. The mortgage crisis showed that people still make mistakes when stakes are high.

Governments have been getting interested in behavioral economics. What are they doing with the research?
I’ve been working with a group within the United Kingdom’s government called the Behavioural Insights Team. One of the first experiments in the U.K. was to encourage more people to pay their taxes on time. We just changed the letter that was sent out to people who owed money, and added the true fact that 90% of people pay taxes on time. So the only difference was that we were telling people, “You are in the minority.” If you are an Econ, this should be irrelevant. But it brought in millions of pounds in tax revenue a lot faster.

There are all kinds of opportunities. Climate change is a behavioral problem—telling homeowners they use more power than their neighbors tends to reduce consumption. So is obesity. Health care costs are partly behavioral. It makes sense to ask behavioral scientists for their ideas, and then test them rigorously.

What about the worry that nudges can manipulate people? It’s just looking to see how we can help people without forcing them to do anything. We didn’t invent the idea of nudging people toward certain choices—it’s been around throughout human history. When the government employs these strategies, there are important ethical questions, and Cass Sunstein and I wrote about this in our book Nudge. We insist the government has to be transparent. Critics forget you cannot have a world without nudging. If people have to remember to sign up for a 401(k), the employer is effectively nudging them not to enroll. Either way, you have to decide what the default is. We advocate picking the one that makes people better off.

MONEY retirement planning

These 4 Rules of Thumb Can Screw Up Your Retirement

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Rules of thumb are often partly true—but the part that's wrong can wreck your portfolio. Here's what you need to know.

Retirement planning can get complicated, so we often fall back on rules of thumb, or “heuristics” as economists call them. That approach may work sometimes—and is certainly better than doing nothing—but it can be dangerous too. Here’s what you need to know about four largely-but-not-completely true tenets of retirement planning.

1. Save 10% a year and you’ll be fine. The appeal of this oft-repeated precept is that 10% is a nice round number that’s achievable for many people. And stashing away 10% of your salary may very well lead to a secure retirement—if you start doing so in your early 20s and never miss a year for the next 40 years.

Problem is, many of us don’t get as early a start on our savings effort as we’d like. Indeed, when researchers for TIAA-Cref asked pre-retirees last year what they wished they’d done differently to prepare for retirement, 52% said they wished they’d started saving sooner. And even if you do get that early start, any number of unforeseen events—a layoff, an illness or injury, an unexpected expense—may prevent you from sticking to your regimen, or even force you to dip into your retirement savings.

Considering that many of us may get a late start or run into disruptions along way, a better strategy is to shoot for a higher savings target, say, 15%, more if possible. That will give you a little wiggle room in case you fall short some years. Better yet, rev up a good retirement calculator periodically, and plug in the amount you have saved and the amount you’re setting aside each year to see whether you’re doing enough. Making small adjustments as early as possible will spare you from having little choice but to save at a painfully high rate late in your career in order to achieve a secure retirement.

2. Your spending drops dramatically in retirement. The problem with this statement is that it might be true—or it might not. The consensus is that spending tends to drop after one retires (and then rebound a bit later in life, according to a study by Morningstar head of retirement research David Blanchett). But there’s also a wide variation around the norm (spending generally drops off less for wealthier retirees, for example). So depending on the particulars of your situation, you could end up spending less, the same or more than you did before you retired, or even more.

So how do you deal with such ambiguity? My recommendation is that unless you have a really compelling reason to believe otherwise, you should save during your career as if you’ll need at least 80% of your pre-retirement income when you retire. Shooting for less requires less saving. But if you underestimate the amount you’ll need and turn out to be wrong, you’ll have to downscale your standard of living, which isn’t an adjustment most people like to make. Once you’re within 10 to 15 years of retirement, you can then start doing an actual retirement budget. An online budget worksheet like the one in Fidelity’s Retirement Income Planner tool can help you get a good handle on the expenses you’ll face, and you can update your estimates as you near and enter retirement. There will always be unexpected expenses and surprises. But you’ll be better prepared to handle them if you do some serious thinking about your retirement spending before you leave your job.

3. Smart investing can make up for anemic saving. There’s a temptation to think that we can compensate for a weak savings effort by shooting for higher investment returns. But that’s wishful thinking. Sure, earning 8% a year for 40 years instead of, say, 7%, will give you an extra $295,000 at retirement, assuming you start out earning $40,000 a year, get 2% annual raises and contribute 10% of salary until you’re 65. But higher returns aren’t just something you can plug into a spreadsheet and then expect to materialize. Other than focusing on low-fee investments, the only way to boost returns is to take more risk, and that makes your retirement accounts more vulnerable to market downdrafts. What’s more, if your high-risk strategy backfires, you could even end up worse in the long-run than had you followed a less aggressive one.

A better approach: Save at an adequate rate so you can set an investing strategy that jibes with your risk tolerance and that makes sense given the forecasts for low rates of return in the years ahead. That doesn’t mean you can’t take prudent risks. During most of your career when growing your nest egg is important, you’ll probably want to devote most of your savings to stocks. But as you get closer to and enter retirement, you become more concerned about preserving the savings you’ve accumulated, so you’ll likely want to scale back on equities. For a guide to reasonable stock-bond allocations, you can check out the Vanguard target-date retirement funds for someone your age. Bottom line, though, is that saving (and once you’re in retirement, spending) drives retirement success, not investing.

4. You won’t outlive your savings if you follow the 4% rule. Back when the stock market was generating long-term annualized returns of 10% or so, this rule worked, kind of. It didn’t guarantee your money would last at least 30 years in retirement, but the success rate for people who followed it were high, say, 90% or so. But with investment pros like Portfolio Solutions’ Rick Ferri forecasting far lower returns for stocks and bonds in the years ahead, that success rate has declined a good 10 percentage points or more. As a result, some experts suggest that an initial withdrawal of 3%, or even less, is more appropriate in today’s market.

But there’s another problem with the 4% (or even 3%) rule that doesn’t get as much attention. Even if you succeed in not running out of money, following it could leave you with a big stash of cash late in retirement if the markets do well. Not a problem, you say? Well, that extra cash is money that you might have enjoyed earlier in life if you hadn’t been restricting your withdrawals.

I recommend you start your retirement with a reasonable withdrawal rate—say, 3% to 4% if you want your nest egg to last 30 or more years—and then monitor how you’re doing by plugging your savings balances and projected spending into a retirement income calculator that uses Monte Carlo simulations to assess how long your nest egg might last. You can then make small ongoing adjustments as needed, perhaps cutting back on withdrawals if your nest egg’s value has plunged or loosening the purse strings if a booming market has boosted the balance of your retirement accounts.

In short, when it comes withdrawals, as well as the other three tenets cited above, a rule of thumb may be a decent starting point, but you’ll have to exercise some creativity, flexibility and common sense to get you the rest of the way.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY retirement planning

1 out of 3 of Workers Expect Their Living Standard to Fall in Retirement

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But you don't have to be among the disappointed. Here's how to get retirement saving right.

One third of workers expect their standard of living to decline in retirement—and the closer you are to retiring, the more likely you are to feel that way, new research shows.

That’s not too surprising, given the relatively modest amounts savers have stashed away. The median household savings for workers of all ages is just $63,000, according to the 16th Annual Transamerica Retirement Survey of Workers. The savings breakdown by age looks like this: for workers in their 20s, a median $16,000; 30s, $45,000; 40s, $63,000; 50s, $117,000; and 60s, $172,000.

Those on the cusp of retirement, workers ages 50 and older, have the most reason to feel dour—after all, they took the biggest hits to their account balances and have less time to make up for it. If you managed to hang on, you probably at least recovered your losses. But many had to sell, or were scared into doing so, while asset prices were depressed. And even you did not sell, you gave up half a decade of growth at a critical moment.

Despite holding student loans and having the least amount of faith in Social Security, workers under 40 are most optimistic, according to the survey. That’s probably because they began saving early. Among those in their 20s, 67% have begun saving—at a median age of 22. Among those in their 30s, 76% have begun saving at a median age of 25. Nearly a third are saving more than 10% of their income.

Workers in their 50s and 60s are also saving aggressively, the survey found. But they started later—at age 35. And with such a short period before retiring they are also more likely to say they will rely on Social Security and expect to work past age 65 or never stop working.

Interestingly, the younger you are the more likely you are to believe that you will need to support a family member (other than your spouse) in retirement. You are also more likely to believe you will require such financial support yourself. Some 40% of workers in their 20s expect to provide such support.

By contrast, that expectation was shared by only 34% of those in their 30s, 21% of those in their 40s, 16% of those in their 50s and 14% of those in their 60s. A similar pattern exists for those who expect to need support themselves—19% of workers in their 20s, but only 5% of those in their 60s.

Workers are also looking beyond the traditional three-legged stool of retirement security, which was based on the combination of Social Security, pension and personal savings. Those three resources are still ranked as the most important sources of retirement income, but workers now are also counting on continued employment (37%), home equity (13%), and an inheritance (11%), the survey found.

Asked how much they need save to retire comfortably, the median response was $1 million—a goal that’s out of reach for most, given current savings levels. Strikingly, though, more than half said that $1 million figure was just a guess. About a third said they’d need $2 million. Just one in 10 said they used a retirement calculator to come up with their number.

As those answers suggest, most workers (67%) say they don’t know as much as they should about investing. Indeed, only 26% have a basic understanding and 30% have no understanding of asset allocation principles—the right mix of stocks and bonds that will give you diversification across countries and industry sectors. Meanwhile, the youngest workers are the most likely to invest in conservative securities like bonds and money market accounts, even though they have the most time to ride out the bumps of the stock market and capture better long-term gains.

Across age groups, the most frequently cited retirement aspiration by a wide margin is travel, followed by spending time with family and pursuing hobbies. Among older workers, one in 10 say they love their work so much that their dream is to be able stay with it even in their retirement years. That’s twice the rate of younger workers who feel that way. Among workers of all ages, the most frequently cited fear is outliving savings, followed closely by declining health that requires expensive long-term care.

To boost your chances of retiring comfortably and achieving your goals, Transamerica suggests:

  • Start saving as early as possible and save consistently over time. Avoid taking loans and early withdrawals from retirement accounts.
  • In choosing a job, consider retirement benefits as part of total compensation.
  • Enroll in your employer-sponsored retirement plan. Take full advantage of the match and defer as much as possible.
  • Calculate retirement savings needs. Factor in living expenses, healthcare, government benefits and long-term care.
  • Make catch-up contributions to your 401(k) or IRA if you are past 50

Read next: Answer These 10 Questions to See If You’re on Track for Retirement

MONEY Ask the Expert

Should I Use Home Equity to Invest for Retirement?

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Robert A. Di Ieso, Jr.

Q: We recently retired. We have a small mortgage on our home and lots of equity. Should we refinance our mortgage to free up additional money to invest for our retirement? —Bea Granniss, Amityville, N.Y.

A: Even at today’s low mortgage rates, it’s risky to borrow against your home at this stage of your life, says Tim McGrath, a certified financial planner and founding partner of Riverpoint Wealth Management in Chicago.

It’s true that more older Americans are retiring with heavy debt loads. But taking on additional debt when you are no longer bringing in income puts you in a precarious financial position. In retirement, your income is fixed—you probably have Social Security, your retirement savings, and possibly a pension. If an unexpected expense comes up, your chief recourse is to adjust your spending on discretionary costs, such as eating out and taking vacations. If you pile on more debt, you may not have enough leeway to avoid cutting your fixed expenses, says McGrath.

No question, refinancing looks attractive now. At today’s low interest rates, freeing up cash for a potentially higher return is a tempting notion—after all, stocks have done pretty well in recent years.

But it’s a mistake to compare today’s low mortgage rates to an expected return on investment, especially for retirees. Moreover, the basic math of refinancing may not make sense given your financial situation.

Let’s start with the refinancing rules. Unless you have a mortgage rate that’s significantly higher – at least a half percentage point above the current rate—you won’t free up much income with a refi. And now that you’re not working, it will be harder to get the best terms from a bank.

Borrowing against your home will reset the loan, which means you’ll be paying more in interest over time instead of paying down principal. “Instead of building more equity, you’ll be racking up more debt,” says McGrath.

Refinancing also costs thousands of dollars in fees. So you’ll need to stay in your home for a long time in order to recoup those expenses. But when you’re older, you’re more likely to reach a point where you want to downsize or move.

As for those enticing investment returns, there’s no guarantee the money you invest will produce the gains you’re seeking—or any gain at all. Lately, many investment pros have been warning that the returns on stocks and bonds are likely to be lower in the years ahead. Most retirees, in fact, are better off with a more conservative portfolio, since you have less time and financial flexibility to ride out market downturns.

Of course, every retiree’s financial situation is different. Refinancing might be a good solution if you want to pay off other high-rate debt. Or if you’re struggling to afford the mortgage payment, and you want to stay in your home, then refinancing could give you more of a cushion for your regular expenses.

But that doesn’t sound like the case for you. As McGrath says, “Taking money from your home equity and gambling on what could happen by investing it is too much risk in your retirement.”

Read next: How to Squeeze the Most Value from Your Home

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