An Inconvenient Truth

There appear to be two great debates of our time—Is global warming (oops, I mean global climate change) real? and How much do people need to save for retirement?

The former is beyond the scope of this column, of course (watching the public debate, I’m not certain but that it is beyond the scope of many so-called experts on the subject). As for the latter point, every so often, some academic emerges with proof that people don’t need to save as much as “common wisdom” suggests they should.

The issue was most recently addressed in a column in the New York Times titled “Are Americans Saving Too Much for Retirement?”—a column that was quickly picked up in syndication across the country. Of course, what are usually taken to task are the assumptions imbedded in those ubiquitous retirement calculators, the notion that one must accumulate a sum able to replace 70% of one’s preretirement income in retirement, and the ministrations of retirement plan providers and advisers who, ostensibly, stand to profit from encouraging a life of hyperactive thrift.

Let me concede a couple of points: Many retirement planning calculators still make assumptions about inflation and market returns that no longer seem founded in reality. They still assume that we’re benefiting from annual cost-of-living increases in our pay, for example. Even applied to costs, does anyone believe that the standard projections are able to keep pace with the escalating costs of health care that we are likely to confront in retirement? As for investment returns, it isn’t that the default investment return is a fiction—it’s just that it is a fiction in view of the way most participants actually allocate their balances (this, IMHO, stands to change with the growing embrace of asset allocation offerings).

As for that replacement ratio of 70%, well, I’ve always wondered if it was high enough, what with soaring health-care costs, the Boomer generation’s notoriously less-than-parsimonious lifestyles, and those refinanced mortgages. But, as averages go, it seems a reasonable place to start.

Therein lies the rub, of course. For the most part, the assumptions on both sides are based on averages of a sort. The “average” 401(k) balance in an individual plan, much less a national average balance, tells you almost nothing about the adequacy of that balance to provide a decent retirement income. To do that, you’d have to know something about that individual’s age, their health, where they live, where they plan to live after they retire, their marital status, their other sources of income, their expectations for spending in retirement….In sum, you have to know something about the individual’s specific situation to have a prayer of estimating how adequate their savings truly are. Besides, averages on things like lifespan tend to gloss over the reality that as many people live beyond that point as not.

Ultimately, like the gas gauge on your vehicle of choice, these calculators can only tell you so much; a full tank in a hummer may not carry you as far as one on that hybrid, a journey up into the mountains may take more than a cruise across the prairie, a car full of family members may need more than that solo trip….In point of fact, a half-tank may do just fine for driving around town, but not for a cross-country vacation. What is “enough” depends largely on where you’re going, and how you’re getting there.

Headlines that claim we may be saving too much belie the reality we see every day, IMHO—and they provide people with a flawed rationalization for their poor savings habits. Let’s face it—the “inconvenient” truth is that most aren’t coming close to saving what those calculators call for. In that sense, claiming that the calculators provide an exaggerated result misses the point entirely. Most people are saving based on what they think they can afford to save or, in many cases, what will allow them to maximize the employer match. In the end, that may be enough—or not.

But, given a choice between a gauge that potentially exaggerates the problem, and one that obscures a harsh reality, seems to me that most would rather be safe than sorry.

- Nevin E. Adams

See “Are Americans Saving Too Much for Retirement?”

See also

“The Lure of Averages”

“Bad Assumptions”