The traditional approach to saving for retirement goes something like this: Save 10% of your income every year, starting as early as you can, and if you can begin in your 20s the compounding growth will let you easily retire 40 years later. If you don’t start saving until your 30s and 40s, you have to save more to “make up” for what you didn’t accumulate when you were younger. In fact, recent research has even developed National Savings Guidelines to build recommendations for the right amount to save based on your current age and how much income you want to replace in retirement.
Unfortunately, though, there are several significant problems with this standard approach. The first is that by relying primarily on compounding a modest amount of savings for a very long period, the results become highly dependent on short-term market results in the final years before retirement. For instance, while it’s true that starting to save $300 a month as a 25-year-old for 40 years in a balanced portfolio at 8% will give you $1,000,000 to retire at age 65, the caveat is that at age 55 you’re not even up to $450,000 yet! In other words, “save for the long run and let compounding work for you” could also be characterized as “save for decades, then quickly double your money and retire.“ Of course, when you look at it that way, it seems a whole lot riskier to count on your money doubling in the last 8 to 10 years. As the last decade has shown in particular, sometimes that strategy doesn’t work out very well.