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Wednesday, September 8, 2010

Work More Years, Increase Saving, Invest More Aggressively?


Yesterday's post was a question of which 3 events would impact an investor's nest egg the most under assumed conditions. The 3 events were: work an additional 2 years, increase savings rate from 8% to 10%, or increase return on assets from 6% to 8%.

Kevin at "Invest it Wisely" first guessed #3 - increase return, but then changed his answer to #2 - increase savings rate. Actually he was right the first time. Before everybody starts tsk tsking and thinking, "yeah, that's what always happens when you change your answer," actually behavioral scientists find that changing answers on tests (better known as second guessing) actually improves scores.

Anyways, for the example, the person will have a nest egg of $420,000 if he doesn't change his behavior. The respective options work as follows (according to "Fiduciary Benchmarks" data):

1. work 2 more years $490,000
2. Increase savings rate from 8% to 10% $540,000
3. Increase return from 6% to 8% $ 560,000.

What if all 3 options are taken? Then the nest egg would more than double to $850,000! It is worth pointing out that working extra years and increasing the savings rate are under the control of the person. For return, he is somewhat at the mercy of the market. It illustrates the importance of asset allocation. From a financial planners point of view, if the so-called "number" required for retirement was $800,000 or so, a bigger allocation to stocks would typically be recommended.

5 comments:

  1. I would have guessed #3 if I had read the original post yesterday, but it would have been a total guess without running the numbers.

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  2. Nice post--the trinity of investing Earn, Save, invest :)

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  3. re: Grouch It isn't obvious at first glance. The impressive thing is the impact of all 3.
    re: Dd Thanks for stopping by and commenting.

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  4. Nice post.

    You have no influence over what your clients earn, so can I assume you advise your clients to save between 8-10% Robert, in products that should get the 6-8% above? (Mostly stocks and a few bonds I assume)?

    Cheers,
    Mark

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  5. Mark:
    I like to see young people start at 10% and quickly get to 15%. I also like at least 20% in bonds even for those who have a high risk tolerance.
    DIY

    ReplyDelete