Are You Saving Enough for Retirement?

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Are you saving enough for retirement? No.

Well, maybe you are. But that would make you an exception, as study upon study show that Americans are woefully unprepared for retirement. Right now, with year-end statements from your broker, mutual fund companies and bank in hand, it’s a good time to rethink your savings rate and asset allocation.

Savings rate, of course, is the percentage of your income you put into long-term holdings, a rainy-day fund and so forth. In the 1990s, many investors figured they didn’t need to put too much aside because stellar stock-market returns would inflate their holdings. The past decade has shown it’s too risky to count on that. A big nest egg is more likely to be built through a high savings rate than stunning investment returns.

Asset allocation means the way your investments are divided among stocks, bonds and cash, as well as subcategories. An investor might assume that stocks will return 8% to 10% a year over time, bonds 5% or 6%, cash 2% or 3%. Since a new retiree may live another 30 or 40 years, some stock holdings are necessary to keep ahead of inflation. But stocks are volatile, so bonds are cash provide stability.

How should money be divided between the various asset classes?  The market-data firms Morningstar (Stock Quote: MORN) and Ibbotson Associates have produced an allocation index  based on historical performance. It suggests that a 24-year-old with a moderate tolerance for risk put 55% of the portfolio into U.S. stocks, 34% in foreign stocks, 5% in U.S. bonds, 2% in foreign bonds and 4% into commodities as an inflation hedge.

A 74-year-old with a moderate taste for risk would keep 27% in U.S. stocks, 8% in foreign stocks, 33% in U.S. bonds, 4% in foreign bonds, 6% in commodities, 17% in Treasury inflation-protected securities and 5% in cash. Look at the table to find the allocation suitable for you.

Are your assets and savings rate sufficient to build the nest egg you’ll need? Use the Retirement Income Calculator and Retirement Planner to find out. They’ll show how big your nest egg is likely to grow given your assets, savings rate and hoped-for investment return, and they’ll show how much income you should be able to draw without outliving your money.

As a very rough rule of thumb, expect to draw 4% of your assets a year. If you earn 6% or 7%, a 4% withdrawal rate will leave a bit of growth to offset inflation, so you can draw a bigger sum each year. At a 4% withdrawal rate, you’d need $300,000 to provide $1,000 in monthly income, $600,000 to provide $2,000, and so on.

Also check out the Retirement Income Calculator from T. Rowe Price (Stock Quote: TROW), the mutual fund company. It uses a different approach, called a Monte Carlo simulation, to figure the odds your plan will produce enough income. It repeats the calculation 1,000 times, using different figures for factors like investment return and inflation.

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