Let’s face it: Retirement is complicated. There’s no defined set of rules of which steps are necessary to retire comfortably. Though frequently advertised, the “One size fits all” approach overlooks the factors that make each individual’s finances unique. What may work for one may not necessarily work for another.
For example, it’s common practice to limit stock holdings as one ages. It makes sense; you have less time to make up for any sort of financial risk that may impede your retirement savings. But what about if you have a defined plan, such as a pension? What if you are more financially secure? What if you want to pass more wealth onto your children?
Suddenly, it may not make sense to limit stocks anymore.
Again, there are so many things to consider when it comes to tailoring the retirement plan that’s best for you. Some other factors that may influence retirement include:
- Retirement income and income trajectory
- Financial capital
- Assets and liabilities
- Human capital (the value of future earnings from employment; an asset that may be more valuable than financial assets)
- 401(k), pension, and Social Security
- Saving and spending behavior
- Risk preference (capital preservations vs. capital appreciation)
Another point to consider is the idea of behavioral finance, or the effect of psychology on investors and markets. After all, we’re all human, so it’s valuable to keep in mind some of your patterns and tendencies when it comes to investing. Our nature can sometimes be an impediment to returns as well. Consider the phenomenon known as recency bias, which is the tendency to believe that recent trends will continue into the near-term.
While this may have served as some sort of survival mechanism in our Neanderthalic age, the market behaves a bit differently. Think about the housing booms of the early 2000s— many believed that housing prices would continue to increase and took on home equity loans as a result. Clearly this trend didn’t last, and one of the largest financial crises since the Great Depression followed as proof.
So what should you factor into making decisions in regards to saving for retirement? It’s vital to evaluate the trade-off between the instant gratification of spending now or saving for later. One thing that may ease anxieties when it comes to calculating your retirement nest egg is that on average, retirees do spend less.
The formula commonly used to quantify the amount of retirement income needed for an individual is known as the retirement income replacement ratio. Typically, a replacement ratio of 70% is needed to maintain one’s lifestyle. It adds up— after retirement, we no longer have wages. Therefore, we no longer pay Social Security tax, and our income taxes are lower too. Additionally, a portion of one’s wage income is used for savings, which no longer applies after retirement. Lifestyle expenditures are also lower, as one no longer needs to travel to work daily or buy clothing.
While this may seem like a comprehensive list of factors to consider when thinking about retirement, it’s really only the tip of the iceberg.
Read a more on RetirementInvestor.io for an in-depth look at retirement income planning, including a useful graphic that visualizes integrated financial planning.