The 80% myth

My previous column, Why it's hard to save enough, sparked many splendid responses. Among them was a gem from one "DrH," who managed the very difficult feat of being spot-on about everything. (I am envious.)

This bit in particular grabbed my attention: Another absurd statement is that you "need" 80 or 90% of pre-retirement income to live on. We're living comfortably on less than half of what we used to earn--the biggest budget category decreases, in order, are taxes, retirement savings and charity.

Bingo! The financial services industry misleads the everyday investor by selling the notion that an 80% replacement rate of pre-retirement income is required for a successful retirement. DrH does fine on 50% of pre-retirement income. My mother and stepfather have no complaints, either. They are now in their 28th year of retirement. During this retirement period, they have traveled the world over--Japan, India, South and Central America multiple times, Switzerland on at least five occasions, London, Southern France, Romania, Italy, and many more. They also hike frequently in the US national parks, indeed they spent last week in the Sierra Nevadas. This was achieved with my stepfather generating a healthy but nonetheless middle-class income, and my mother bringing almost no assets or income into the mix. With each party retiring at age 50. If they had targeted 80% of pre-retirement income as the prerequisite for retiring, they might be working still. (Well, not quite, but very likely until age 70.)

They don't buy new clothes at department stores (unless it's a big sale). They don't often eat at restaurants. If they drink Starbucks, it's because they brewed it at home rather than paying $4 for a latte. They drive a used Kia, not a new BMW, and so forth.

But you know, forgoing those items causes them very little unhappiness. I suspect that they are not alone. I suspect that the large majority of consumers would prefer to cut back on the luxury items that make up so much of their pre-retirement spending--and yes, eating out at a restaurant when one has the time to shop and cook, is a luxury item--if that permitted them to retire on the timeline that they desired.

But who tells people that? Instead, the conventional planning advice is that you want 80% of pre-retirement income, you can reluctantly settle for 70%, and if you only get 50%, you're eating cat food. (Which is partially true, as cats would no doubt adore my mother's grilled salmon, although not her fresh roasted vegetables.)

This mind-set has sunk in so deeply, that it's almost impossible to combat. A few years back, I was in charge of an investment-planning software programme that Morningstar sold to financial services companies, to make available to their 401(k) [US pension plan] employees. I knew that the biggest problem with such programmes is that they are so gloomy--the employee puts in his or her age, assets, targeted retirement, savings rate, etc., and then is told to save twice as much, and work until age 78. At which point the horrified employee exits the programme, and gives up on the notion of investment planning.

So I built the programme to target an initial rate of 50% of pre-retirement income, as a 'floor.' Rather than focus on an 80% rate that few people would achieve, and then show them that their current plan was far short of that objective, the programme steered people toward a more realistic plan. (In fact, it forced them to create a floor plan; if the user did not do that, they would not receive the specific fund recommendations.) The programme contained various prompts to encourage users to see if they might be able to hit higher targets, so it wasn't as if it "settled" for 50%. Rather, it used that as a starting point.

And it never got off the ground. I could not sell that version of the programme to the financial services companies. It wasn't so much that they wanted a higher target so that employees would raise their savings rate, put more into funds, and thereby increase the fund company's assets under management. The companies recognised the truth in my argument that setting a lower target would get more employee participation, so they figured that what they lost by using Morningstar's programme on the one hand, they would gain on the other hand.

No, the problem was that they had been brainwashed by the consultant studies on the subject, the ones that insisted that 70% was a bare minimum for subsistence, 80% to 90% desireable, and 50% meant cat food. They just would not accept the notion that employees should be permitted to create a 50% plan.

So, I gave up. After all, the programme wouldn't be changing anybody's future, if it were never installed. So I upped the floor to 70%--the minimum acceptable figure--and had the programme altered in various ways, so as to be more cheerful, and also to encourage the user to think through retirement needs, and to move the income slider down if he or she so desired.

Which is what you should consider doing. There's nothing wrong with an 80% target. That's my current goal; it works for me. But it may not always work for me, in which case I will be happy and completely unafraid to downsize. So should you.