funds (ETFs) are a critical ingredient here. Unlike mutual funds, which have cost and tax inefficiencies, ETFs often provide the building blocks to assemble a robust portfolio at low cost. In conjunction, algorithmic advice can scale practically infinitely using technology. This provides portfolio management techniques that previously were the reserve of secretive quantitative teams to be publicly available. This means both the instruments and the techniques to ensure a successful retirement are now broadly available. The benefit here is not in lowering the costs of an existing service, but in expanding the reach of that service. Previously, even with relatively high fees, it simply wasn’t economical for a financial advisor to serve a client with less than half a million in assets. The percentage of assets to make it worth the advisor’s time would eat into the client’s investment returns and provide only a meager return for the advisor. This meant that prior to digital investment services, most of America was in the painful position of not necessarily wanting to manage their own investment portfolios, but often having to do so because there were few other viable choices open to them.
The Magic of a 15 Percent Savings Rate
However, we should remember that even the smartest techniques and lowest fees cannot solve the savings rate problem. Prospective returns can be improved but there is no magic wand. With a 6 percent rate of annual growth, you can double your money in 12 years, but if you save nothing, you’ll still end up with nothing at the end. That’s true however long you have to save and however well balanced a portfolio is on offer.
And, unfortunately, the savings challenge is getting harder, not easier. The global increase in life expectancy is a good thing, but it puts a lot more pressure on your retirement dollars that now have to last years longer than previously. Retirement actually is a relatively new phenomenon. Previously, people would quite literally work until they died. At the end of the Second World War, the average life expectancy of an American at birth was 65, meaning that many would have no retirement at all. Now, for those born in 2010, it is just over 78.6 That is an increase of 13 years over two generations, and so retirement moves from being a short period to something most people can plan on experiencing for a decade or longer. The moves for an increased retirement age are unsurprising in the context of this stark improvement in life expectancy and quality of life for the elderly. Figure 1.2 shows U.S. life expectancy at age 65 over time, and the trend of increasing life expectancy is clear: this puts a greater burden on retirement savings as the retirement period lengthens.
Figure 1.2 Life Expectancy in the United States since 1930
Source: Centers for Disease Control and Prevention
Without proper planning, retirement may also be a luxury. This is an understandable outcome if Social Security diminishes in significance and savings rates remain at low levels. Increasingly, retirement is being delayed or potential retirees are continuing to work in old age. In the past two decades, the proportion of Americans expecting to retire after age 70 has more than doubled, from 9 percent to 26 percent, according to EBRI data7 from 1991 to 2015. Sometimes this is a lifestyle choice to remain active and engaged and avoid the abrupt lifestyle shift that retirement can represent. Now, 1 in 10 workers expects to carry on working into old age, and never retire, that figure has more than doubled recently, up from 4 percent in 1991. However, for many, delayed retirement is likely to be an economic necessity given the harsh reality of low savings rates.
Your savings rate makes a big difference to your retirement outcomes. Without Social Security payments, if you are able to earn 6 percent in real terms on your savings and spend 80 percent of your prior income in retirement and save consistently over 30 years, then a 5 percent savings rate, which is the around the current average savings rate in the United States can be expected to last around five years, which is shorter than most can expect to live in retirement by many years. And remember, many will live longer than the average life expectancy. A 10 percent savings rate may last around 16 years on similar assumptions. However, if you are able to save 15 percent or more from your income, then the same analytical framework suggests that you may be able to fund retirement from your savings indefinitely, since at a certain point the real income on the money you saved covers your retirement expenses. This is the ideal goal, since at this point you have sufficient financial security, even if you beat the odds and live much longer than actuarial tables would suggest.
Figure 1.3 shows life expectancy in the United States if you live to age 65. There’s a good chance most people have 20 years of retirement, but longer periods of up to 40 years are quite possible. Jeanne Calment of France has the longest documented life span, living to be 122 years.
Figure 1.3 Years in Retirement
Source: National Vital Statistics System, 2007 U.S. Data for Both Sexes, FutureAdvisor Analysis
Of course, this is a relatively simple analysis, with Social Security or other strategies like selling your home and moving to a smaller one excluded. However, it does assume that you are able to live off 80 percent of your pre-retirement income.
One hidden benefit of a high savings rate, such as 15 percent, is that you are training yourself to live off less than your full income, which is helpful come retirement. Conversely, if you are using debt to finance expenses, then you are probably living off more than your income, which makes saving for retirement harder still. That’s why a 15 percent savings rate is a good rule of thumb because you are not only building up a healthy nest egg, but you are living off 85 percent and that means your lifestyle is less expensive to fund in retirement than if you were spending 100 percent of your salary.
However, savings rates vary crucially with time to retirement. The preceding analysis assumes 30 years to retirement, for example, someone at age 34 looking to retire at 65. If you have more time, then your savings rate will be lower, but if you are older, then a similar savings rate won’t meet your goal.
So America has a retirement problem. Savings rates are falling as life expectancy increases and the ability of Social Security to fully fund itself is in question. Fortunately, digital investment advice offers part of the solution in helping savers make robust investment decisions, but even the smartest investment systems cannot be effective if savings rates remain at very low levels.
● America’s savings rate is low relative to history.
● As life expectancy has increased, retirement has increased from a period of a few years after working to potentially many decades for some. Savings have not kept pace with this change.
● Saving 15 percent of your income over 30 years is ideal for a comfortable retirement.
Chapter 2
The Risk of Not Investing in Stocks
“I’d like to live as a poor man with lots of money.”
What if in Vegas there was a game where you could potentially double your money? Sure, you say, what are the odds? Oh, there’s no major risk based on history, everyone who plays makes
Elizabeth Arias, “National Vital Statistics Report,” United States Life Tables, 2010.
