Ben Stein How Not to Ruin Your Life

I hate to be a nag, but I'm afraid I must. Think of me as a parental figure nagging you for your own good. Remember last time (wasn't that fun!) when I told you the advice from one of the smartest financial planners around, Raymond J. Lucia? That advice was to match financial assets with financial liabilities (see "Three Big Mistakes in Retirement Planning").

For most of us, by far our biggest financial liability is going to be our retirement. Living without working is not easy, and it's getting more difficult as defined-benefit corporate pension plans go the way of the do-do bird. To live comfortably off your capital requires a very large amount of capital relative to our earnings.

This is cruel (and financial writer Lee Eisenberg wittily called me "Freddie Kruger" for daring to mention it), but it's true. I must now tell you the sad news about just how very much you need to save.

Watch Out for Inflation

Let's assume you're a 40-year-old woman with no especially large debts, your own home, and a good job. Let's be very generous in our assumptions about how well you've been saving. Let's assume that you earn about $50,000 per year, but you've done well with your saving and have $100,000 stashed away already.

How much do you need to save to have a decent standard of living in retirement, making the following hypotheses?

1. Your income will rise to about $100,000 (unadjusted for inflation) by the time you retire;
   
2. Inflation will cause prices to rise at about 3% per year;
   
3. You will need to have 85% of your pre-retirement salary to live comfortably upon retirement;
   
4. But -- and this is a huge qualifier -- inflation will continue at that same 3% after retirement, and you'll need to have your retirement income grow at 3% per year also to keep pace.

How much do you need to save? I put this question to my investment counselor, friend, and colleague, Phil DeMuth. Together, we strategized about what investment portfolio the woman in our example should have.

A Whopping Chunk of Savings Needed

We decided that she should have 70 percent in stocks, divided as follows:

• 35% in the Vanguard Total US Stock Market Fund (VTSMX), which is about 90% S&P 500 and about 10% small cap
  
  
• 35% in the Vanguard Total International Stock Market (VGTSX), which is roughly 90 percent in the large-cap stocks in Europe, Australasia, and the Far East, and 10% in emerging markets.

That totals to 70% of her savings. Then she should have 30% in bonds, of which:

• Half would be in the Vanguard Bond Market Index (VBMFX), which mimics the very broad Lehman Brothers Aggregate Bond Index
  
• The other half would be in the Vanguard inflation adjusted bond fund (VIPSX).

Phil ran this portfolio through what is called a Monte Carlo simulator. This dumps in all known years' and months' returns in these investments, and tells you how, on average, they have performed. It's a wildly complex calculation, but computers do it almost at once.

What Phil and I (mostly Phil, of course) found was that to get to the sum she needs, this woman needs to save a whopping 20% of her pretax income every year (adjusting for inflation each year) to get to $2,000,000 (roughly) dollars. With this sum, she can withdraw $85,000 the first year, then raise it each year by inflation, and she has a 90% chance of keeping herself comfortable until age 87, not counting Social Security, and a 75% chance of funding it through age 100. Since she owns her own home in our hypothetical situation, she could do a reverse mortgage on it -- presumably by then it has an enormous value -- and use some of that money if she needed it.

Bring in Expert Help

There are several points here. One is that the amount of saving the pre-retiree has to do even with a fairly good head start is fantastic. If she starts with nothing at age 40, she has to save close to half of her pre-tax salary to get where she needs to be. So, prepare to save a lot. We're disregarding Social Security here. If it's still solvent, you'll need to save a little less.

Second, you must remember that inflation will still be eating away at your savings after you retire. Many people forget that, and it hurts them dearly. As Phil likes to say, the 65-year-old retiree is still a long-term investor. (Ray Lucia has a program that deals with that fact in a sound, sensible way. It's called "Buckets of Money." Remember, Ray and I often speak on the same podium about retirement and are paid by some of the same people who sell investments, none of whom are mentioned in this column.)

Third, these calculations are complex. It's the rare citizen who can do them in his or her home. I can't overstate the importance of having a financial advisor from a reputable firm. Trying to make these calculations by yourself is just plain beyond most of our ability.

So, have fun, enjoy the spring, but stay in touch with reality. Get a financial advisor you can trust, get a plan, follow the plan, and sleep at night before and after retirement.