Who Needs To Be A Millionaire? You, If You Want To Retire
By Jane White, President, Retirement Solutions Foundation
After Enron employees lost nearly $1 billion in their 401k plans because they were heavily invested in its stock, the legislative debate has focused on whether there should be limits on company stock, more freedom to dump it, or simply better advice on why overdosing on it can be lethal to your portfolio. Congress is expected to vote on legislation addressing these issues in September.
Unfortunately, no legislation is really aiming at the biggest danger facing retirement savers, which isn't having too many eggs in one basket, but not accumulating enough eggs in the first place.
To hear the media tell it, the biggest threat to the nation's nest eggs is either corporate chicanery or the current stock market slump. But if you do the math, you realize that even during the market's 1995-99 bull run, the nation's nest egg was woefully inadequate. Sure, $1.8 trillion in 401k assets at the market's peak is a lot of money if you don't have to divide it in among 39 million participants. But when you do and you get $49,000 you're looking at a nice chunk of change for a sports car but a paltry amount for somebody who's likely at the halfway mark to amassing a sum of money that has to last for to 25 or 30 years.
The rule of thumb is that you need a nest egg that's approximately 10 times your salary right before you retire-a sum that takes into account Social Security and a company-paid pension, if you're lucky enough to collect one. Assuming that your pre-retirement pay is about 10 times your starting pay, a 25-year-old earning $25,000 a year today will need to amass a $1 million nest egg 40 years from now when he or she is ready to retire. So a million-dollar nest egg for somebody making less than the median wage of $42,000 isn't a windfall. It's the goal.
How do you build a million dollar nest egg? The easiest way is to start saving when you're young, when the last thing you're thinking about is retirement. Because of a phenomenon called compound interest, your investment dollar works twice as hard if you put it to work when you're 25, than if you waited until 35, when you're STILL not thinking about retirement because you're buying a house and starting a family.
How likely is it that 401k savers will learn how to build a million dollar nest egg? When Congress returns in September, they have a choice between accepting House-passed legislation that allows the financial institutions that manage 401k money to advise participants as long as their conflicts of interest are disclosed or backing a Senate bill that requires an independent party to give the advice. Unfortunately, neither option is going to result in adequate advice, according to my research on retirement planning software offered by Morningstar Inc, mPower.com Inc. and Fidelity Investments.
For one thing, all three planning tools allowed a white-knuckled user's fear of stock market volatility to result in a portfolio loaded up with cash and bonds instead of reassuring the user that there has never been a 20-year period when stocks have produced a negative return. The key to success is hanging in there because you can never predict the best time to be in the market. For example, if you had missed just 40 days in the 10-year bull market ending last February you would have actually lost money rather than enjoying an average annual return of 12.62%.
More importantly, all three products allowed poor savings habits to dictate a meager lifestyle in retirement-and offered contradictory advice on how to achieve that lifestyle. When I plugged in my age as that of the median 401k saver: 43 and my account balance as the median: $49,000, I was told how to jack up my savings rate--to anywhere from 10% of my salary to 60% of it, depending on the software--in order to aim for a nest egg replacing 50% of my final pay. The better advice would be to take drastic action to produce affluence-such as switching to an employer with a more generous plan, getting rid of credit card debt (incredibly, roughly equivalent to the assets in 401k plans) or buying a home if I haven't already (home equity accounts for around 70 percent of most people's retirement assets.)
If anything, today's workers need a relatively fatter nest egg than their parents did. Out-of-pocket medical expenses will rise, with fewer employers covering what Medicare doesn't. Prescription drug costs are soaring out of sight. And then there's that pesky problem with Social Security, whose promised benefits are expected to drop by 25% when the trust fund dries up in 2038.
As a former journalist, I suspect that none of these advice-givers want to deliver the bitter medicine because recipients of bad news tend to shoot the messenger (and blame the employer-who is paying the messenger). But somebody's got to get the message across while investors have time to change their savings habits.
What's ironic is that the same employers who have avoided giving sound retirement planning advice because of fears of lawsuits may end up as the defendants in a different kind of lawsuit: age discrimination. Once the nation's 65ers discover that their low three-figure balances probably won't support them for five years, much less 25, they're going to want to keep working when jobs may be scarce. At that point the retirement savings crisis won't be an expensive problem. It will be an unsolvable problem.
Jane White is President of the Retirement Solutions Foundation and a former financial journalist. She can be reached via e-mail at Jane@retirement-solutions.us. The Retirement Solutions Foundation is a non-partisan organization dedicated to educating the public about saving for retirement.
