Get Real
Presenting U.S. News's ultimate retirement calculator--the essential tool you need to plot your strategy for the future
Does this mean it would be prudent to assume that you, too, will earn 7 percent over time? If you do, you should be aware of the risks. Never mind the Great Depression; if you'd begun saving for retirement in 1953 by investing in a portfolio of all common stocks and had made equal investments each year through 1973, the average annual real return on your portfolio would have been -0.65 percent. Too bad if 1973 happened to be the year you wanted to retire.
Because bull markets are inevitably followed by bear markets, many financial advisers suggest putting an increasing share of your retirement portfolio into bonds as you age to protect money you can't afford to lose. But the long-term real return on bonds is only 3.5 percent, and for long periods the return has been negative; between 1966 and 1981, the average real return on bonds was -4.2 percent. History suggests that a prudently mixed portfolio of stocks and bonds will earn substantially less than 7 percent over the long haul.
Also uncertain is what effect aging baby boomers will have on markets once they begin to draw down their savings in retirement.
The nest-egg illusion There's enough money in my 401(k) to buy a minivan; I must have enough to retire on.
In 1995--the latest year for which data are available--more than half of all families headed by a person 35 to 44 had retirement savings; the median amount was $25,000. Assuming a prudent real return--let's say 4 percent--$25,000 will grow to $54,778 over the next 20 years. That may sound like a huge amount, but how far will it go? If you retire at 65 and live to 90, a nest egg of that size will allow you to spend just $3,500 a year without depleting your savings before you die.
The mortality illusion I'll live to about the same age as my parents did.
People tend to underestimate their life expectancy, and it's not surprising. It's the look-around problem again: You generalize from life spans of older friends and family members and figure that's what's in store for you, too. But in an era of rapidly improving life expectancy, the look-around method once again gives the wrong answer.
Life expectancy at age 65 today is 15.6 additional years for men and 19.2 for women. For both sexes, this represents an increase of more than two years just since 1970. By the time the youngest baby boomers turn 65, the Social Security Administration projects that life expectancy at that age could be as high as 18 more years for men and 21 years for women. Note that everyone runs very nearly a 50 percent "risk" of living longer than their life expectancy.
That reality makes retirement planning exceptionally difficult. On the day a husband and wife turn 65, they may have only a year or two of living between them to finance, or they may have 70. A good rule of thumb might be to plan against the possibility that you will outlive three quarters of the people in your age group--an actuarial calculation our Web site calculator allows you to make. You may not want to deny a child a college education just so you are sure to have enough money to celebrate your 95th birthday, but you also don't want to become a burden on your children just because you unexpectedly live to be 10 years older than the average life expectancy for people your age.
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