One of the complexities of retirement planning is that there are so many variables. At what age will you begin saving? How much will you save every year? What return will you earn on your retirement fund? When will you retire and how much will you want to spend during retirement? Finally, how long will you live? Because these are all unknown, financial planners do computer simulations in which they examine the outcomes of different combinations of these variables. The goal is to develop a plan that provides a high probability of a satisfactory outcome across a range of conditions.
I was curious as to which of these variables is the most critical, so I developed a base case in which an individual begins saving at age 25 and retires at 70. Assumptions regarding the savings rate, annual portfolio return, and retirement spending were middle-of-the-road and designed to ensure that the retirement fund lasted until age 95. The point of the exercise was to determine the impact of an equal percentage change in each assumption on the age at which the fund runs out. The other assumptions were held constant in each case.
| Age at Which Retirement Funds are Exhausted | |
| Base Case | 95 |
| Reduce Savings Rate | 93 |
| Reduce Portfolio Return | 91 |
| Increase Retirement Spending | 93 |
| Start Saving Later | 91 |
| Retire Earlier | 94 |
The decreases in retirement fund longevity do not seem catastrophic, but it is important to note that they are based on modest changes in the assumptions. For example, the base case assumed an 8% investment return whereas the alternative reflects 7.5%. Obviously, greater changes in the assumptions would result in much shorter runways. For example, the fund would be completely drained at age 88 assuming a 7% return.
The two most important variables are portfolio return and the age at which the retirement savings program begins. Investment return is largely outside of your control; you will get the returns the markets give you. Additionally, there is considerable risk in “chasing” extra return. Therefore, the most important thing you can do to ensure a satisfactory retirement is start saving early. Next comes the saving rate and level of retirement spending. Both involve balancing the pleasure of current consumption with the goal of ensuring retirement funds match or exceed your life expectancy. Interestingly, the least impactful was the decision to retire at age 67 rather than at 70. I personally believe in stretching a career because it maintains a sense of purpose and promotes good social health. However, this analysis suggests the financial impact of earlier retirement may not be too severe for those who are ready for more leisure time.
This is a very simple analysis which is not meant to obviate the need for more sophisticated planning. However, it does provide a sense of the impact of key variables and helps set personal priorities.