Most retirement planners are facing a gap.
I'm not talking about orthodontics. I'm talking about the gap between where your savings are and where you want to go.
If you've taken the initial retirement planning steps--setting some money aside and investing it-- you've set a course. Using your existing investing strategy and savings rate, we could create a line graph estimating the growth trajectory for your retirement nest egg. There are no guarantees, but we can make educated estimates.
Follow that line to see where your nest egg could be at the time you hope to retire--maybe age 60, 65 or 70. This is where you're going.
Do some math to figure out how much money you'd need to have at retirement in order to live the retirement lifestyle you'd prefer. This is where you want to go.
The difference between your current trajectory--the path you're presently on--and your desired trajectory is the gap.
The process of figuring out how to resolve your gap is called gap analysis. It helps uncover what changes you can make now in order to alter your trajectory and reach your retirement goal. And it puts your goal in perspective, helping you to decide whether it's realistic.
Step One: Evaluate how much money you would need in order to retire at the age you desire and live the lifestyle you want.
Start with your present budget. Consider which of your expenses you expect to eliminate or reduce and which will remain steady or increase. Account for extra expenditures like travel and new hobbies, and remember to incorporate medical and long-term care expenses. A lot of people simplify this calculation by thinking in terms of income replacement: what percent of your current income do you need to replace with retirement income? Many financial advisers suggest 70-80 percent of your pre-retirement salary; however, that range may not work for your needs. That's why it's important to run the numbers for your personal situation.
Once you know your annual income needs, you may want to find a retirement calculator to help you measure your total cumulative need. Calculations should include (a) the number of years you plan to be retired--and it's safer to overestimate your lifespan rather than underestimating; (b) an approximate rate of return you anticipate from your retirement investments after you've retired; and (c) your annual expenditures.
Step Two: Determine how much money you're on track to accumulate by retirement, based on your present savings and investing behaviors.
With historical data from your asset class allocation, going back as far as possible, you can calculate an approximate net rate of return for your current and future investments.
Step Three: If there is a gap between your predicted needs and your predicted savings (and most people do have a gap), determine what you can do to get more money into your retirement savings. That's generally going to happen in two ways: save more or create an investing strategy geared toward your earnings goal.
Saving more money is fairly simple: adjust your present-day budget by eliminating unnecessary expenses so you can comfortably contribute more money to your 401(k) or other retirement savings plan. Create a timeline for contribution increases so you can ease toward a better savings rate, and plan to increase your contribution rate each time you get a raise.
To maximize your investing strategy, create a portfolio allocation that fits your risk tolerance and spreads risk across several asset classes. Simultaneously, select funds that have historically performed well relative to peers, have reasonable expenses and have low turnover on the management team. But, please keep in mind, while it's important to evaluate historical performance, remember that past performance is no guarantee of future performance.
Step Four: If there's still a gap, adjust your retirement lifestyle expectations. For example, you could delay retirement for a few years, work part-time during retirement, plan to live in a more modest home, give up that golf membership or travel less?
Simply saving for retirement without a strategic plan is not enough. Uncover the gaps in in your strategy while you still have time to make corrections.
Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.
More From US News & World Report