Michael Kitces On The Right Way To Save For Retirement
Taylor TepperForbes Advisor Staff
Updated: May 28, 2021, 6:00amEditorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn’t affect our editors’ opinions or evaluations.Courtesy Of Michael Kitces
In fact, with all the demands of day-to-day life, you may even be comforted by that rule-of-thumb: I’m not sure how much I’ll need for retirement, you might think, but at least I’ll be OK if I save that much.
That’s because how much you save for retirement is only half the battle. The other less-discussed consideration is how much you spend. The more you spend, the more savings you need when you retire to sustain your standard of living. And Kitces thinks we are allowing ourselves to spend too much before we hang up our spurs.
His point is intuitive, if not depressing: If you spend 85% of every raise you earn (while saving the other 15%), your standard of living rises so quickly that you’ll never really be able to save enough to fund your retirement.
That’s why Kitces wants workers, especially younger ones, to adopt a new mantra: Save half of every raise.
Forbes Advisor recently chatted with Kitces about navigating the challenges of lifestyle creep and retirement savings. The following interview was edited for clarity and length.
What is lifestyle creep and why is it a problem for retirement?
As we get going in our careers, making a little more and doing a little better, our lifestyle starts taking some upticks as well. Good for us! We’re earning more so we can do nice things in our lives.
But, and I see this when we meet with clients in our advisory firm, as their lifestyle starts to pick up they get further from hitting their retirement goals, even though they’re saving a decent chunk of their income.
How can that be?
Start with an industry standard rule of thumb that ends up compounding this problem in really challenging ways: Save 15% of your income. That feels good, especially as I’m watching my account balance grow.
But it doesn’t work so well in reality.
Say you’re making $40,000 straight out of college, and then $50,000, $60,000 and then $70,000. If you’re saving 15% of each of those raises your savings has gone up, but there’s a problem.
If I calculate how much money you need to retire living a $70,000 lifestyle instead of a $40,000 lifestyle, you are so much further in the hole because your lifestyle has gone up by 75%!
Note: Kitces lays out the math for various retirement scenarios in a piece he wrote on his blog in 2017.
So what should people do?
The problem with saving 15% of your income is you’re going to spend the other 85%. If you do that as a standard rule, every time you get a raise, you’re going to spend 85% of your raise and save 15% of your raise.
If you keep adding 85% of your raise to your lifestyle and only adding 15% of your raise to savings, guess what? You fall further and further behind. If you don’t want to fall behind, you need to think about it differently.
When you get a raise, spend just half.
Spend just half. I don’t say save just half, even though that’s what’s going to happen, but it’s less fun than the spend part. Spend just half.
So if you got a $2,000 raise, plan to add another $1,000 to your lifestyle. If you get a huge $10,000 promotion, take $5,000 and go on a new vacation, take on a new car payment, whatever it is that you want to do. But only lift your lifestyle by half of your raise.
You’re still going to get to do more things. But when you slow down the pace of lifestyle creep, your savings rate gets really big really quickly.
Take the raises I mentioned before. If I actually went from $40,000 to $70,000, that’s $30,000 worth of raises. If I save half of every raise, that means I’m saving $15,000 annually. If I’m saving $15,000 on $70,000, I’m saving 20% of my income. And remember, you weren’t saving anything when you started.
This is how we get to a nice savings rate.
Imagine going from earning $40,000 to $100,000. By the end, you’re making $100,000, but only living off $70,000. You have a 30% savings rate and you still got a huge upgrade on your lifestyle from where you were earlier. Meanwhile, the rule of thumb would have had you save only $15,000.
You didn’t upgrade all of the raises; you just upgraded some of the raises.
That sounds good, but I feel like I’m going to need to spend more than that by the time I retire, no?
No matter what we say now, the truth is that until we’re just a few years from retirement, we have no idea.
We project our life in retirement to be whatever my life is like today, with slightly more gray hair, or slightly less hair, and a few incremental tweaks.
What’s the significance? Where we take our path while we’re living it has a huge impact on what we end up expecting retirement to be. If your lifestyle doesn’t creep higher, your vision for retirement is what we’re doing today with some slight adjustments.
This has different implications depending on where you are in your life, right?
Yeah—there are two separate groups of people. There’s the group that’s already well into their career, who, for better or worse, is living that ratcheted-up lifestyle now, and frankly it’s really hard for them to change.
We get used to a certain lifestyle: It’s one thing to say you bought too much house, and it’s another to say correcting that would mean moving away from friends you’ve made in the area. It’s one thing to say you need to eat out less; it’s another thing to say you need to have a different social circle. That’s a different conversation to be had another day.
The group I’m aiming at are the people in their 20s, 30s and maybe 40s. The reality is, the bulk of the lifestyle changes that ultimately have such a major impact on how much you need for retirement—how big that egg needs to be—that group hasn’t made those changes yet. They still have choices.
Even just sending yourself on a different trajectory makes a big difference.
And you’re slowing down the dreaded lifestyle creep.
Exactly. If your lifestyle doesn’t pick up as much, you don’t end up needing as big of an egg.
So now suddenly the savings rate is growing faster and the nest egg required is growing more slowly. The lines are coming together.
I guess people don’t miss money they never had…
It’s easier if you start before you get used to it.
When you’re living the lifestyle and someone says you have to save more, “Well, what the heck am I supposed to give up? I don’t want to give up the things I do; I do them for a reason. I like doing ’em!” So it’s hard to give that up.
When you commit to saving half of every future raise, or only spending half of every future raise, you’re only giving up things you never had and so you won’t miss them that much.
I’m not saying all of it. We do like to add things to our lives, but just spend half. And watch how your situation transforms.
Culled from Forbes