Why You May Need to Save Less Than You Think for Retirement

Katie: Welcome back rich girls and guys to the Money with Katie Show. Today's episode might feel a little contradictory. You may have looked at the title and thought, "Personal finance, personal say what? I might even just say less than I think." You heard me. While I have certainly seen some budgets that would make Chris Jenner cringe, I actually think there is something to be said for the realization that you are going to be okay based on your current habits. The inverse of this realization obviously is that you're not going to be okay based on your current habits, but when I look at the boomers, who mostly experienced life in a time before personal finance content was a thing, and they were, I don't know, more or less winging it, it seems like time is on most people's side.

Katie: Boomers, after all, have an average net worth of $1.2 million while millennials have an average net worth of $100,800 per CNBC. Are the boomers smarter? Are they better? I mean maybe, but probably not. Maybe they're just older. They've been in the market longer. And while they certainly didn't have the student loans or the home prices that we're facing today, they did have a few gnarly bear markets that would've had their money more or less earning nothing for not insignificant amounts of time. And investing for the boomers looked really different than it looks for us, the millennials.

Katie: In the 1980s, when the boomers were in their twenties and luckily starting to invest, investing required actually having a broker, paying for trades and, oh, index funds were really just starting to take off in popularity. It was not as easy as opening up your pocket computer and dumping some money into a robo-advisor who would do it all for you for practically nothing. In fact, I will make an even crazier claim. As long as you are happy to generate income for the majority of your life, you are almost definitely going to be okay. This is where the fire movement is slamming a million doors and sounding a litany of smoke alarms. Well, what if you don't want to generate income for the majority of your life?

Katie: And look, when taken to extremes, I get it. Nobody wants to work 60 hour weeks forever. Hell, I don't even think I want to work a 40 hour week forever, but working to generate some income, that honestly doesn't sound too bad, it actually sounds nice. And that's the crux of this episode. You may not find yourself soaring into the sunset with Bill Gates and matching private plane, but most people are going to be mostly okay. Of course, I want you to be more than okay. I want you to be spectacularly wealthy beyond your wildest dreams, and that's why Money with Katie exists, to create more financially free young millionaires. But, for some people, that creates a lot of pressure and burns them out. And when I show you that you'll likely... I'm doing air quotes... only have the inflation adjusted equivalent of $1.3 million in retirement, even if you contribute the maximum year 401k for every single year for 25 years, people get upset.

Katie: They say, "What? You mean I can only spend $52,000 a year in retirement even if I'm contributing the maximum?" It's like watching someone come to the realization that though they never had any real plans to make it happen, they're not going to end filthy stinking rich by contributing to one investment account for the better part of three decades. But let me ask you this, is that so bad? Is that really the worst case scenario? You only have a million dollars? Think of it this way, if you're working for 25 years and contributing the inflation adjusted equivalent of $20,500 each year to that account, you're putting in 512,500. You'll end up conservatively with 1.3 million. You doubled your money, you more than doubled your money. What if you worked for a couple more years to support yourself and you just let that money ride? The compounding magic starts to take off around year 35.

Katie: That's because between years 25 and 35, you turned 1.3 million into 2.6 million by doing nothing. That assumes a real rate of return of 7%. If you're willing to generate enough income to support yourself, not even necessarily enough to save more or add anymore, you will still double your money again in that last decade without adding another dime. So why will most people end up mostly okay? For me, it all comes down to proportionality and inertia. As long as you're not actively going into consumer debt to support your lifestyle, meaning you are only spending money that you actually have, there's a pretty simple way to judge how many years you're going to have to work before you are a retirement eligible. This is because spending 90% of your income means, by definition, that you are saving and hopefully investing 10% of it.

Katie: Spending 80% means you're saving 20%, spending 50% means you're saving 50%. You get the picture. You will likely grow accustomed to the lifestyle that you can live with that amount of money, and this is where inertia comes in. You get used to eating that type of food, sleeping in that brand of pajamas, taking that type of vacation. In other words, you're going to adapt to your circumstances, you adapt to that level of income. Every time you get an increase in income, you can recalculate your save rate based on the amount of that raise that you choose to spend and the amount that you're saving, and as a result, you recalculate your timeline.

Katie: So depending on how much of your raise you save, you'll either move the finish line closer or further away. Let's do an example with big, easy round numbers, because I think it'll help illustrate this point. If you make $100,000 after taxes and you save 50,000 of it, that means you're spending 50,000 of it. In order to be financially independent, you would need 50,000 times 25, right? 1.25 million. And how long will it take you to save or, well, invest the inflation adjusted equivalent of 1.25 million if you are saving $50,000 per year? It only takes about 15 years, and it'll really be around 1.8 million not 1.25 million because of inflation, but 15 years. A save rate of half, regardless of the numbers, will always work out mostly the same way.

Katie: It takes roughly 15 years, give or take crazy market moves that may push you over the edge faster or slow you down a little bit, but in the end it really is all a game of proportions. If you get a raise and now you make 150,000 but you still only spend 50,000, your new save rate is 66% and your retirement timeline just got closer. Now, it only takes about 12 years. Note though that spending too much of a raise actually pushes the timeline further away because you've been saving this whole time as though you only needed $50,000 per year to spend, so if you begin spending much more, your work optional number increases.

Katie: The average American works for about 40 years and saves 11.9% of their income as of 2021. Now, assuming this person only ever gets 3% increases in income each year, right? That little merit increase or small cost of living bump, and they increase their spending proportionally, like another 3%, they would need to increase their save rate to 15%, not 11.9, to end up okay. But most people don't earn that way. Earning more income later in life and as you progress in your career tends to help these people pick up a little more steam as long as they don't inflate their lifestyles proportionally. So let's dive into when I realized that it was actually likely that most people were going to end up mostly okay. And honestly, it wasn't examining these proportions or averages, it wasn't diving into a spreadsheet on my own hypothetically that made me come to this conclusion, it was something much nerdier.

Katie: Anytime I would have a friend who wanted to talk numbers with me, I would whip out my financial independence planner. I am pretty proud of it. It uses a super conservative average return, it accounts for inflation in your accumulation phase, and it allows you to plug in different salary changes, or just assume that you're going to get a 3% bump every year. So it only really uses a few inputs, what you already have invested, your current income, and it takes out 25% for taxes, which is also a little bit high for an effective tax rate because we are being conservative. Your expected returns after accounting for inflation, it's usually a real return of around 5% in the planner, because again, I like keeping it conservative, I don't want to overshoot and then be sad later when things don't play out the way I thought they were going to. And then your current spending, which I always tell people, pad it a little bit. You want to be safe. And then that spending is baked in increase by 3% per year for inflation.

Katie: So the first time I really noticed that someone's outcome was going to be much better than I thought, was when I was running the numbers for a friend who has gotten a little bit behind but she makes great money, she just haven't really saved much of it yet. And I was expecting to be the bearer of bad news to her. I thought, "Oh my God, she's not going to be able to retire until she's 75. I'm really afraid to plug in these numbers with her," but we did it and something amazing happened. Because of her high income and her relatively reasonable spending, certainly not frugal but definitely not paycheck to paycheck, retirement was only about 15 years away, which was, well, before she turned 75. I thought, "That's a pleasant surprise."

Katie: And then another time, I was helping a friend who got a bit of a late start. She hadn't really been earning money for a few years, she had bounced from job to job, and money just wasn't really a priority for her. So after I badgered her to sit down with me and do this exercise, she agreed and she didn't have much save yet but she had recently found steady employment that she liked. And here's the key part. Even though her income was average, her save rate was amazing, 30%, and we plugged in her numbers, bought a bing, bought a boom, she'd be work optional in 20 years. Again, a total surprise. So why did my friends' outcomes keep surprising me? Well, the simple answer is probably that, in my world of fiery rhetoric, and high incomes, and high save rates, and short working lives, they're the norm.

Katie: So when I plug in my family's numbers, we will be work optional with our fine number of 2.4 million by the time we're 30 if things go as planned, because we are psychopaths and we have made a number of really ridiculous decisions to put ourselves in that position. It's not average, by any means, but it was really important to us. But the reality that I was beginning to learn after I sat down with these friends and were working on their numbers with them, is that really can make relatively average decisions and, shocker, get average or maybe even above average results.

Katie: Despite not spending their twenties or thirties, in some cases, stockpiling a giant pile of Scrooge McDuck cash like I had, they had kids, they lived their lives, they spent a month in South America, they took six months off, they went back to school in another country, they're still going to be able to retire in less than 20 years and it got me thinking, "Man, it seems like maybe this extreme nature of the fiery rhetoric is just that extreme. Okay, that's it. I am packing my bags. I am booking the flight.

Katie: And I am setting off for the adventure of a lifetime.

Katie: But wait, what about my glorious plan of being [inaudible 00:12:33] or 30?

Katie: Only there were a nationally recognized wealth management advisor on the other side of this break to help me iron this out.

[AD BREAK]

Katie: Well, why didn't you know it? There is a nationally recognized wealth management advisor that just walked in the door. Funny how that works. And this is really fantastic news because I wanted to talk to someone with a financial planning background who could speak to both the chances of running out of money and retirement as well as the wellbeing side of things.

Kim Curtis: Hi, I'm Kim Curtis, CEO of Wealth Legacy Institute, and we work with individuals and families transitioning into retirement.

Katie: Kim, welcome to the Money with Katie show. Thank you so much for making the time to chat with us.

Kim Curtis: Thanks Katie.

Katie: So Kim, the crux of this episode is really simple, that your retirement may not actually be as doomed as you think it is even if you've gotten a late start or you're feeling like you might be a little bit behind. So can you speak to the primary reasons that you typically see retirement fail, so to speak, and are they often financial or does it sometimes come down to other things?

Kim Curtis: It's interesting because retirement, more often, fails, primarily not because of financial reasons, it's really not about the money. So when we think about observing people progressing from saving for retirement to then living in retirement, I think what often comes up is that they miss some pieces in between and ultimately wonder what the big question is, what's next?

Katie: That's so funny. This is always why when I write, or record, or interview people, it seems like, without fail, every single topic ends up boiling down to these big existential questions about who we are and what it means to live a good life, because that's the whole point, right? Why does it matter how much money you have if you don't know who you are without a full-time job? So how do you work with clients to set up a game plan that's not only financial but helps them avoid some of these retirement traps? You had mentioned the Ds and the big B, I think, when we were chatting before this so I would love for you to go into depth a little bit there.

Kim Curtis: Yeah. After the novelty wears off, after a couple of months, you may find you have no reason to possibly get up in the morning. Without vital engagement, what we've discovered is that many people experience the dreadful Ds, Katie, that you and I mentioned earlier. And one of them is depression, discovering that it's not as originally envisioned as you had hoped, and you feel let down, and discouraged. Another is divorce. Your home, or with each other more often, and you recognize that this isn't really the person that you want to be. And a lot of people may have felt that during the pandemic, is discovering their relationship and how it fits in. There's another one that's dependent. Sometimes couples rely on one or the other to find social engagement or to have community, and who their friends are, and they may not have their own friends.

Kim Curtis: And then I think the one that you probably appreciated just because it stands out so much is the drunkenness. You think about social circles and activities sometimes combined with boredom, can cause excess alcohol consumption. So that big B is boredom. Unless you really know what's important to you and you have hobbies that allow for social engagement. It's really easy to fall into that big B and that's really where you see a lot of failure when it becomes to achieving financial independence and the word retirement.

Katie: I have so many flashbacks right now to any long break I've ever had from school or work where you have a couple weeks off. That doesn't happen often, but when it does and you're like, "Man, the time that I start boozing is creeping further and further up in the day as I realize that I'm just sitting around doing nothing." So I've seen very small bouts of that myself. So I want to talk about the hierarchy of financial independence and I'm picturing this very Maslow hierarchy of needs pyramid here, but can you walk us through how you think about the multi-layered needs of someone who is choosing to walk away from traditional employment beyond the money side of things, or maybe the money side of things is the basis of the pyramid?

Kim Curtis: Yes. I love the pyramid example because it really outlines how financial planning fits into everything that we're trying to achieve with financial independence. So it always starts at the bottom of that pyramid with money. And then as you work your way up, you have financial goals, and then you have life, and then you have impact. So money goals, life, impact. On the bottom, the money piece, that's your savings and budgeting, that's your cashflow management, that's your tax minimization asset class portfolio design. As you move up to goals, that's your financial planning, your protection planning, tax planning, estate planning, education funding. And then when you move up to life, that's really taking those two things, money and financial planning, and merging those together to create peace of mind.

Kim Curtis: And when you have peace of mind, you have harmony, and your life is in balance, and you feel good about where you're going, and you have direction, and you have no stress and worry. When you have no stress and worry, it's easy to get to the top, the pinnacle of that pyramid, and that's where you have impact, and your life is extraordinary, and it provides meaning to others. And what that is, involves community, and family, and so forth. So you can have all the money in the world and have a failed retirement, and that's because, as you said, that hierarchy of needs with Maslow, well, it's true with money too, that you need to make sure you work your way through that pyramid so that you're in alignment with your life and you have harmony and you feel great about things.

Katie: I love that. I love the impacts at the top. And it's funny because I think sometimes when we talk about this side of retirement, that's like, "Hey, you could have plenty of money and spend all your working life worried about not having as much money as you're going to need, but at the end of the day, you're really not going to have the retirement you want to have if those other non-financial needs aren't being met." But I do want to highlight the money is important. We're acknowledging in this pyramid, the first two layers are all financial.

Katie: For me, listening to you describe that, reinforces this sense that there is no true security without financial security. This is something that is really worth focusing on and not losing sight of. So I always want to strike that counterbalance when we talk about this stuff, where I'm saying, "Hey, you may not need as much as you think you do, but make no mistake, this is a very important part of the equation and it is worth your attention."

Kim Curtis: I totally, absolutely agree that you have to have money as your foundation, but if your inner needs are not satisfied... That's the key. If your inner needs are not satisfied, no amount of money will be enough.

Katie: Beautiful. Thank you for that. Kim, thank you for being here today.

Kim Curtis: You're welcome. Thanks Katie.

Katie: It was a pleasure. So there you have it. Maybe the fear we have around retirement is justified, but it might be a little bit misdirected. It is very possible that these questions have been largely ignored in your own reflections about the future. And do you remember in the beginning of the show when I was talking earlier about the disappointed millionaire, the 401k millionaire, who was bummed that she was only going to have $1.3 million, she was only going to be able to spend $52,000 per year? When I did that calculation, I used her real income of $60,000 and 52,000 is about 86% of 60,000, and the goal income in retirement is usually around 75% of your working income according to T. Rowe Price.

Katie: I will also note here that this is another feather in the cap of the traditional over Roth 401k argument. This analysis and report from T. Rowe, I'll link it in the show notes, shows that your income taxes and retirement are likely going to be lower than they are now in general, but also because you're not paying the 7.65% [inaudible 00:21:14] attacks and retirement that you have to pay right now on your earned income. Anyway, I digress, but not only that, most retirees actually spend less over time not more.

Katie: Nick Maggiulli wrote about this in his book, Just Keep Buying, that when you examine the average expenses of retirees, aged 65 to 79, their spending actually starts going down, not up. The JP Morgan asset and management research pointed to the fact that spending in retirement typically declines at a rate of 1% per year, and this is great news since most retirement calculators, including mine, bake in 3% increases annually for inflation. And the data would suggest that, that's just not how retirees actually behave. And it all paints a much rosier picture of the second halves of our lives, and it raises a question for me. Yes, we should probably make some sacrifices to get where we want to go, but it actually might be fewer than we expect.

Katie: Who hasn't spent a month in South America? Who hasn't gone back to school at another country? Who hasn't taken six months off ever? Me. I may be on track to retire in my thirties but I didn't really live my twenties to their fullest, and I'm hopeful that that means that I'll get my payoff in my thirties, and that my thirties will rock and whatever, but there are plenty of experiences that I skipped, or avoided, or ignored because they cost money or time that I didn't think I had. I thought I had to save every penny and work every free hour, and yadda yadda yadda.

Katie: We may be millionaires before we're 30, but I've spent most of my twenties working multiple jobs, skipping concerts, missing weddings, foregoing vacations, because I thought that they were going to meaningfully derail my progress. Maybe the better question is, should you rush to the finish line if you don't even know what you're going to do when you get there? So the bottom line is this, you're probably going to be okay. The bar is not as high as even I would have you believe it is sometimes but much like my investment projections are conservative, sometimes I like to push myself and you a little further than necessary just to make sure that we both end up pleasantly surprised later as opposed to disappointed.

Katie: All right. Thanks for listening. That is all for this week. I will see you next week, same time, same place, on the Money with Katie show. Our show is a production of Morning Brew and is produced by Nick Torres and me. Alan Haburchak is the director of audio in Morning Brew, and Sarah Singer is our VP of multimedia. Sam Cat is our executive chaos agent who knocks my phone off the table and gets the zoomies while we record, and Bin Dog is our chief of wolf who lets us know when the UPS man comes to the door while we are recording.