New way of looking at retirement
By Carmel Fisher, Director
14 July, 2017
Retirement advice hasn't changed much over the years. Most retirement planning strategies centre on the concept of starting as early as you can, saving consistently and letting compound growth work for you over time.
Such strategies assume a linear relationship between your savings behaviour and your retirement outcome: if you can save $300 per month from age 25, you will accumulate a million dollar retirement nest egg by 65 (assuming an 8 per cent growth rate over time).
The biggest problem with this traditional advice is that, in real life, an individual's spending and income patterns don't follow an orderly straight line.
Our ability to save can vary throughout our life, influenced by promotions or redundancies, and family events like starting a family or moving to an empty nest phase later.
Investment market cycles and timing can upset the best laid plans. While an adverse market event won't necessarily hurt someone in the early years of accumulation, it can drastically de-rail a plan if it strikes just as you are approaching retirement.
The idea of steady as she goes retirement savings is not as achievable as the conventional view suggests.
American financial planner Michael Kitces has proposed a different way of thinking about retirement planning based around four phases: Earn, Save, Grow and Preserve.
Kitces says, in the first stage of saving for retirement, the key issue is not saving but ensuring you earn enough to be able to afford to save.
It's all very well saying you should start saving early but, for many people on lower incomes, there isn't much spending to cut in order to save.
Instead Kitces says the focus should be on earning as much as possible, so you can save in the first place. He suggests the key to financial success is to earn more to save more.
Success in the second phase, the savings part, is to manage your spending and saving behaviour to make it happen.
By this stage, you'll have enough income to cover the bills and have something left over.
But lifestyle creep can lead to the temptation to spend more so, even as our income rises, there's still no money left over to save.
Here Kitces suggests automating saving behaviours or finding a way to "pay yourself first". The outcomes of this stage will be influenced by your ability to rein in life choices and stick to saving.
Once you have cemented savings habits in place, you will enter the third phase where retirement savings are so large that the way you are investing your savings is more important than your ongoing contributions.
Your portfolio's investment strategies matter at this point. In the early years, improving returns by one per cent per annum has a relatively trivial impact compared with saving another $100 per month.
After a couple of decades of saving, adding one per cent to your annual returns has quite a significant impact.
Kitces says in this growth phase, ensuring you have the right balance of risk to generate sufficient returns can have a dramatic impact.
As your retirement draws near, you enter the preservation phase where - with a shortening time horizon - preserving your retirement savings and managing risk become dominant factors for success.
If there was a market decline at this stage, additional savings could not make up the difference.
Ultimately, Kitces says, effective retirement advice will vary over time rather than following a standard straight line.
The 'right' retirement advice for you depends on which phase you're in.