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After some of last weekend's discussion, I wish to continue my war against the finance industry for focusing on the question of "how much money can my money make?" instead of what should be the primary question for financial planning, "how much money does my money need to make, given how much I save and spend?" The latter question allows for people to reach financial goals through adjusting saving and spending levels, as well as by seeking appropriate returns on savings/investments. The former question just looks at accumulation of assets through earnings, which obviously is good for those selling means to get high returns. The bottom line is, unless you accept the mythology of very high returns above inflation (e.g., from 100% stock allocation with historical statistics), how much you can save matters more than returns on investment.

A very crude, but easy and effective, calculation can be made by assuming inflation is zero and expenses and savings are constant over many years. We then can use "real return" (above inflation) for earnings on investments. In reality, of course, inflation will not be zero, but if income and expenses go up at the same rate, it will more or less even out. And, of course, most people's expenses, including such variables as taxes and children, are not constant, nor is income, with it typically being easier to save more closer to retirement (which makes savings, not return on investment, an even more important factor).

Here are some simple numbers, if we assume you save \$1000/month for 25 years, holding inflation and expenses constant. I refuse to consider anything over 5% real return, because I consider that wishful thinking.

At 5% real return, you have \$594,000;
At 4%, you have \$513, 549
At 3%, you have \$445,666
At 2%, you have \$388,642
At 1%, you have \$340,600.

Now lets look at each of those as savings as a % of expenses (\$12,000 per year savings).

At 10% savings rate, expenses would be \$120,000. Even at the highest rate of return, your initial withdrawal rate would be over 20%. Not a going to last long.

At 20% savings rate, expenses would be \$60,000. Even at the high rate of return, you'll still have an initial withdrawal rate of over 10%.

Now, if we get to a 40% savings rate, the 5% real return gets close to a 5% initial withdrawal rate, which theoretically, is a pretty safe withdrawal rate if you can get 3% above inflation after retirement, and don't retire before about age 60. Even at 4% real return on 40% savings, you get a 5.8% initial withdrawal rate, which can last about 28 years at a continuing 4% return.

At 60% savings rate, at 3% return, you get an initial withdrawal rate of 4.5%, which gets you 36 years at 3% return after retirement. If you got 4% return before retirement, your initial withdrawal rate would be 3.9%, which gets you 36 years at 2% return after retirement.

At 80% savings rate, you get a 3.8% initial withdrawal rate at 2% return before retirement, which lasts about 37 years at 2% return after retirement.

At 100% savings rate, you get a 3.5% intial withdrawal rate with 1% returns before retirement (like putting it all into I-bonds at their low point), which lasts 33.4 years at 1% after retirement.

Now, before anyone panics, the assumption here is that these savings are total assets. If people also have Social Security, pensions, home equity, etc., assets will be higher or initial withdrawal rates lower (part of expenses will be paid by SS). Also, I use 25 years as accumulation phase, which I think is a realistic gloss for most people, who tend to be able to save little early in working life (especially with children and mortgages). And, I'm talking about % of expenses of the sort that will continue after retirement (including income taxes, usually much less than in working years, but not Social Security) not 40% of income.

Still, I think the bottom line is, anybody who is hoping to maintain lifestyle after retirement saving only 10-20% of expenses and counting on the stock market to do their savings for them, is operating on a wing and a prayer.

But the good news is, especially if you do have other assets, saving at a 40% of expenses rate can get you where you need to go with realistic expectations on returns, although I know I wouldn't retire at age 65 with a 5.8% initial withdrawal rate and hoping for 4% real returns, if I didn't have some aces in the hole (like SS and home equity). Also, if people are saving at an average of 40% of expenses for more like 30 or 35 years, even if much of the savings is at a higher rate later in life, they should be in pretty good shape.

Once we get to 60% savings rates and higher, again especially if there is also SS and home equity and more than 25 years of savings, the goal of maintaining lifestyle should be readily achievable with a conservative approach to investing, using a prudent, appropriate % of basic stock assets (such as a Total Market Index Fund) plus fixed-income assets, such as TIPS/Treasuries and CDs and Investment Grade Corporates.

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