Solving the Millennial Retirement Savings Challenge

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Last week was a big week in the financial world — America Saves Week! From February 25th through March 2nd, the finance community came together to help impact the lives of Americans through motivating, encouraging, and supporting them to save money, reduce debt, and build wealth (particularly through automated savings).

Now, there is an important distinction to make here; “saving money” doesn’t just mean adding money to your bank account, it means paying down debt as well. When working with clients, there are two main metrics I like to focus on:

  • The first is Net Worth. This is the concept of how much money, investments, and “stuff” you have, minus how much debt you owe. As you grow through life, this number should continue to increase every year, which can be achieved by either saving money or paying down debt.
  • The second, and more relevant metric is a little bit harder to describe and calculate.  To boil it down, it essentially summarizes “What is the likelihood you will be able to retire at a decent retirement age and not run out of money?”  There are a lot of factors to consider when running this sort of calculation; I use advanced statistical software to run this type of projection.

I want to talk about both of these metrics in this post.  Because while many millennials are doing a good job saving in general – either by adding to their bank accounts or paying down debt,  statistics show that many of us are “behind” when it comes to retirement savings.  

Why Retirement Will Be a Challenge for Many of Us

Currently, we are saving significantly less for retirement than previous generations did, for several reasons:

  • Student loan payments. Many millennials are directing their would-be retirement savings to pay off student loans in a way that our parents and grandparents did not have to do.
  • Rising cost of housing. When our parents and grandparents were our age, buying a house was much more affordable. For a typical family, the cost of a home was only around 2 times their average annual salary. In today’s economy, purchasing a home on average costs about 4 times their average annual salary — and that is not even considering that most of today’s jobs are in large cities, where the cost of housing is even higher.
  • Lower company retirement benefits. Most of our grandparents had pensions through their jobs. Some of our parents even did too. Because of the rise in independent contractors and the gig economy, it is becoming harder and harder to come by solid retirement benefits — even 401(k)s are harder to come by than they used to be. Average employer contributions have fallen, too, which is putting more pressure on the individual to save on their own.
  • Relatively flat wage growth since the financial crisis. Since around 2008, there has been very little wage growth across the country, meaning that while prices have gone up, our incomes haven’t necessarily. We have less spendable money than previous generations, making it harder to allocate a significant portion of it to retirement savings
  • Social Security and Medicare are expected to cut benefits in 15-20 years. Having these programs to fall back on when we retire might not even be a possibility for a lot of millennials. If these programs are cut, it will mean that much more pressure is put on the individual to completely financially support themselves through retirement.

Simply put, we face a greater set of challenges in preparing for retirement than our parents and grandparents.  Which means that unless we prepare accordingly, we will either need to delay retirement or partially sacrifice one of the most beneficial strategies we can use to help save for retirement…

Compound Interest

 Compound interest is often described as “magic” or “a miracle” for people trying to save up money over time. The idea that the we can keep our money invested — and the return will exponentially increase over time — is a very appealing one to investors of any age. Consider the graph below.  If this year we invest $1,000 at an 8% rate of return, next year we will have $1,080, in 10 years we’ll have $2,200, in 20 years we’ll have $4,600, but in 40 we see this number grow all the way to $22,000. In the simplest of terms, earnings go from $0.80 in the first year, to $1,750 in the 40th year (that’s a pretty significant increase!).

This looks amazing — and it is! — but there is one key takeaway you should note — you need to keep your money invested and untouched for a very long time to see the “magic” of compounding happen.  Compound interest is a beautiful thing, but we lose most of the benefit if we don’t start investing early enough.

(And, of course, the chart above assumes a constant, consistent 8% investment return each and every year.  While the long-term annual return in the stock market is around 8%, we know that it can vary drastically from year to year!)

As we’ve already discussed, as a generation we are putting more and more money towards student loan payments and housing costs.  Which, in turn, means that less and less money is being put towards savings that will compound in retirement accounts and we begin to lose the impact of the compounding, making it harder for us to have enough money to retire at a “normal” age.

Retirement Shouldn’t Be Your Only Priority!

This isn’t entirely a bad thing.  One of the major criticisms I have of the financial planning industry is the degree to which we focus on retirement.  I started Pacesetter Planning back in 2016 because I believe that financial planning should be about more than just saving for retirement.  Short-term goals, such as buying a house, planning a career change, and paying down debt are important too!  The key is finding the right balance between your short- and long-term financial priorities.

Ultimately, you shouldn’t be putting all your money aside for retirement.  Too many people in this world work as hard as they can, in jobs that they hate, saving as much as they can for 40 years so they can “retire”… and then abruptly change everything about the way they life their lives. Instead, you should create your dream life right now so that you won’t be in a rush to retire in the first place!

Saving for retirement is important… but I’d rather have you create a fulfilling life, balancing your short- and long-term goals, and work in a job that gives you energy, doesn’t burn you out, and is something you won’t be in a rush to retire from.  But, of course, you will want to retire at some point… so how should you approach retirement savings if you feel “behind” in your long-term savings?

The Answer is Surprisingly Simple

To be prepared for retirement, the key is to continue to save more — even if you’re not directly saving for retirement.

Remember, paying down debt is an entirely valid form of saving, including your mortgage debt if you have it (although buying a house is NOT a way to save…more to come on that next week!).  So while you may not be doing a lot of “traditional” retirement saving at the moment, that doesn’t mean that you aren’t saving at all.

This brings up the question — How can short-term saving help you if the money isn’t going into retirement accounts? Well, there are two primary inputs into the calculation we use to determine how much you need to save for retirement, and short-term saving can have a big impact on one of them.

  1. How much do you have saved? This is pretty intuitive, and what we usually focus on. Once you have enough money in your retirement accounts, you can retire.  This input includes the amount of money you are currently saving for retirement, and how much you expect your cumulative savings to be worth by the time you retire.
  2. How much do you spend each year? The second component doesn’t have anything to do with savings at all… or at least, it doesn’t have anything to do with savings directly.  In order to know how much money you need to retire, we need to know how quickly you’re going to spend your money in retirement.   The more you spend, the more you’ll need to have saved for retirement.

The last sentence above hints at the key link between how your short-term savings and debt paydown can help you retire earlier.  The more you spend, the more you’ll need to have saved for retirement.

The problems holding our generation back from saving for retirement largely aren’t related to spending at all!  We’re saving… but the savings is being redirected elsewhere.  Which means that if you continue saving at the rate you’re saving, even as you pay off your student loans and accumulate enough money to make a down payment on a house, you’ll need less money set aside for retirement to begin with because your spending is low!

That’s worth repeating: If you lower your spending today, and build the habit of saving so that you continue to save once your loans are paid off, the less you will need to save for retirement in the first place. Saving money – even for short-term goals – helps you retire earlier because it decreases the amount of money you need to retire in the first place.

Think of retirement savings as filling a bucket with water. Over the course of your career, you’re putting money into your retirement savings “bucket”. When you retire, you start spending that money you’ve saved – for the sake of this metaphor, let’s say that when you retire, you poke a hole in the bottom of the bucket so water starts to leak out of your “retirement savings”. How quickly the water flows out of the bucket is critically important. If you spend a lot, you better make sure you have a TON of water in that bucket before you poke the hole in it, because the water is going to flow out of the bucket really quickly.

On the other hand, if you only poke a small hole in the bucket, the water inside will flow out of the bucket very slowly.  Which means that you don’t necessarily need a huge bucket of water to begin with!

If you want to spend a lot of money during retirement, you need to make sure you save enough to be able to retire comfortably.  The more you spend, the more important compound interest is to you. But if you keep your spending in check, the water will leak slower, meaning that the bucket has to be less full in the first place.

Big Idea: There is a “Double Benefit” When it Comes to Increasing How Much You Save:

Increasing your retirement savings will fill up the retirement savings “bucket” faster, which will certainly help you retire earlier.  But, filling the bucket is only half the equation.

If you’re spending less money, you’re slowing the the speed at which the water flows out of the bucket in the first place, which means that the water level does not need to be as high. If you are able to do both of these things, you can maximize your potential savings and have much more flexibility in when you can retire.

The key, though, is to be able to maintain this over time. Once you student loans have been paid off, redirect this type of saving to saving for something else. Even if you can’t save for retirement right now to fully benefit from the “magic” of compound interest, you can still put yourself in a great position to retire. By following these saving tips, and assessing what you would like retirement to look like for you — you can easily put yourself in the position to get where you want to be!

If you still have questions, or would like help walking through a savings plan, please contact me and we can set up a free introductory call!