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Feb 24 2011

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What’s Better Than Learning From Your Investment Mistakes?


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The only thing better than learning from our investment mistakes is learning from somebody else’s. 

As Baby Boomers are winding down their work schedules, many of them are finding, according to this Wall Street Journal article, that their investment accounts aren’t going to cover their living expenses.

Hopefully, the current generation of workers is going to learn from the Baby Boomer’s mistakes.

You could argue that the Baby Boomers had a better environment for wealth accumulation than any generation in history.  The 30 year work span from 1981 to 2011 saw businesses handing out pensions (dream on generation X and Y).  There was also an employment environment that was so relatively cushy; many boomers were able to work for the same company their entire lives.  And the stock market took whatever savings they did choose to invest and catapulted their investment accounts into the stratosphere.  But myriad reports still suggest that the boomers messed up.

Let’s focus on investing for a moment, to see how the average professional boomer should have done:

Just $2,000 in 1981 would have turned into more than $30,000 by January 2011, if a Canadian worker split his/her money between a Canadian stock market index, a U.S. stock market index and a bond market index.  …read more

 OK, I know what you’re going to say.  You couldn’t buy index funds in Canada, in 1981.  That’s true, but my point here demonstrates how much the markets moved upwards during that time period.  We did have actively managed mutual funds, and if they could have turned $2,000 into $26,000 over that 30 year period, you’d be looking at a compounding gain of 9% annually (a return that underperformed the market index from 1981 to 2011).

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Current Principal:

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Annual Addition:

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Interest Rate:


%

Compound interest

time(s) annually

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startend of each compounding period


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That would have included the crash of 1987, 2002 and 2008/2009.  All told, the boomers had a great environment for investing.

So let’s have a look at how tough it would have been for a boomer working 30 years to amass an investment account that would generate an income of nearly $40,000 a year.

Assume that they saved $5,000 between the ages of 25 and 30 (that’s $83.33 per month for 5 years).  Then they invested that money in a batch of really inefficient mutual funds.  I can’t help taking a stab at the mutual fund industry, but if the markets moved ahead by 10.5% a year, then after hidden investment fees, the average investor might have made 9% annually in mutual funds.

Then assume that they saved $333 per month for 30 years (roughly $4,000 per year), investing in those really inefficient mutual fund products again.

Granted, during the 1980s, that would have been a lot of money.  So perhaps they could have invested less than this earlier on, while catching up when their salaries increased over time.

At 9% annually, this would have given the boomers an investment portfolio of $660,339 if they invested $333 per month for 30 years.

With an insurance annuity (not a variable annuity) they could ensure $39,620.34 a year in retirement income (roughly 6% of their investment), not including any money they’d accrue from CPP or Old Age Security.  Including these two government income sources, they would be earning $50.000+ in passive retirement income.   

Inputs

Current Principal:

$

Annual Addition:

$

Years to grow:


Interest Rate:


%

Compound interest

time(s) annually

Make additions at

startend of each compounding period


Results

Future Value:

$

 And if they had their home paid for at age 65, they’d be set to live reasonably well after having saved an average of $76.92 per week ($4,000 per year) over just 30 years of their working lifetimes. 

 But according to The Wall Street Journal article, most Boomers have fallen short of their potential.   The biggest problem with people not meeting their investment goals is probably due to a spending issue.  They live lifestyles that they can’t afford, without recognizing that they can’t afford them.

Learn from the boomers.  They were given the world on a platter, and if the U.S. data in The Wall Street Journal article is any example, they messed it up. 

 My guess?  I think the average boomer spent too much. 

What do you think?  And what’s in store for the next generation?  Will the average generation X/Y/Z worker benefit from the Boomers’ failure?


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About the author

andrew hallam

I'm a freelance finance writer, lucky enough to have been nominated as a finalist for two Canadian National Publishing Awards. I'm also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School, a book explaining how I became a millionaire on a teacher's salary, while still in my 30s. Working to empower people financially, I'm available to motivate and inspire people on basic retirement planning and index investing. I'm happy to comment on your questions, first, please read the Terms of Use.

Permanent link to this article: http://andrewhallam.com/2011/02/what%e2%80%99s-better-than-learning-from-your-investment-mistakes/

19 comments

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  1. avatar
    Steve in Oakville

    Timely post Andrew! I turned 40 a couple of months ago with the milestone, I've been giving retirement income some serious thought. I've been crunching the numbers to figure out how much I need to contribute and what rate of return I'll need to achieve my goals.

    In terms of the article, they used 85% of pre-retirement income as the basis for 'maintaining standard of living'. That seems very high to me. Most of the Canadian sources I've encountered look at a 60-70% rate, and many even think this is scaremongering. Expenses are drastically reduced in retirement: no mortgage, less money going to kids, less taxes, no RRSP savings etc. It seems that 85% would be quite the lavish retirement.

    What's your take on this?

    Steve

  2. avatar
    cynical investor

    Andrew,

    You mentioned a few times 'Huffington Post' but the article is from Wall Street Journal.

    Am I missing out on something ? Just curious.

  3. avatar
    Andrew Hallam

    @Steve in Oakville

    Hey Steve,

    I think you're 100% right. Despite what that article suggests about needing 85% of your working income to retire comfortably, I think that's a bit crazy.

    There are so many personal factors that go into that equation. Personally, I think I could retire comfortably on 50% of my current salary, maybe less. I think the equation should have far more to do with people's spending habits than their income. What I think people should start with is the question, "How much does it cost me to live today?" Then they need to subtract work associated costs, add in any extra income the government will provide, and figure out what that will possibly amount to when putting inflation into the equation (say, 3% compounding per year). To me, that makes far more sense than a simple percentage of income as a determinant. What do you think? I'm interested to hear your thoughts on this.

  4. avatar
    Andrew Hallam

    @cynical investor

    Hey Cynical!

    Thank you! You're absolutely right. Not sure what I was thinking there!

    What do you think about Steve's general question Cynical? Do you think a suitable retirement portfolio determinant should be based on a given percentage of income?

  5. avatar
    cynical investor

    Not really, it should be as you said be based on the costs of living rather than a percentage of income.

  6. avatar
    Steve in Oakville

    As I said, this is all very timely for me so I've got some thoughts on this.

    I absolutely agree – a percentaged based goal is not really the best way to do it. My parents have a great deal – my dad worked for Revenue Canada and has an indexed pension and they have a little next egg from RRSPs that is basically gravy. With the 25-30K they get annually from CPP/Old Age, they have more money now then they ever had. They sold their house and started renting about a year ago because they wanted to travel and didn't want to worry about a house when they were away. I tell this story because their 'house' expenses actually went up in retirement because they started renting. So while it's generally the case that housing expenses go down in retirement, it's not always true. In other words, a percentage goal is only a very general aim – it's not appropriate for everyone!

    I think your approach Andrew makes the most sense – how much of your current expenses would vanish once work stops? What do you want to do when you retire? Travel the world? Buy fancy cars? Well, then a higher 'percentage', at least in the early years, will be necessary.

    Regardless, even the most aggressive estimates I saw (from the Canadian banks basically) suggested an 80% replacement rate, and the consensus was that this is much too high. With 85%, you'd be living like a king and probably end up in higher marginal tax rate when you take Canada Pension/Old Age Security into account. That's probably not ideal…

    These are the 'scary' percentages that makes people think they can't be happy in retirement without amassing a couple of million in retirement.

    Are the US gov't pension plans and support along the same lines as Canada's? The higher percentage discussed in the article could be because Americans are responible for a greater percentage of their retirement income than Canadians. Just a random thought.

    Steve

  7. avatar
    Andrew Hallam

    @cynical investor

    So Cynical,

    You, Steve and I all agree that a number based on projected expenditures makes more sense. I wonder why it's so expected that people calculate a percentage of their working income to figure out what they'll need during retirement. I suppose people get used to drinking all the water they pour into their buckets. But really?

  8. avatar
    Andrew Hallam

    @Steve in Oakville

    Hey Steve,

    Thanks for your thoughts. It's great to hear that your parents are doing so well. And your story about them does emphasize how individual everyone's circumstance is. One area where Americans fear they could be left out to dry is with medical insurance. I work with a bunch of Americans over here in Singapore, and their medical insurance has always been the holy terror of their retirement nightmares. That might abate, somewhat, if the Obama admin can make some permanent changes. But for now, I think retiring in Canada, as a Canadian, is a heck of a lot less stressful than living south of the border. Any Americans out there agree? Disagree?

  9. avatar
    Steve in Oakville

    Hi Andrew – I hadn't thought about health care costs. Presumably lower tax rates make up some of the difference, but it is nice for Canadians to know that, whatever happens heath-wise, we're protected.

    Steve.

  10. avatar
    Andrew Hallam

    @Steve in Oakville

    You're right Steve,

    And often, lower tax rates = more money spent on things that people don't need.

  11. avatar
    My Own Advisor

    Great post.

    My wife and I hope to retire in 20 years or less, at 55. We're thinking once the mortgage is paid off, we'll be able to live off about 60% of our current salary.

    We're not counting on CCP, but if we have it, we have it. OAS is simply a bonus.

    I think our country could be in for a major shock in another 10 years when we have almost as many folks retired as working. That's why we need our nest egg built now, and a war chest of dividend paying stocks like Canadian banks, energy companies and telcos for passive income won't hurt us either.

    Really though, what is learning when you can't apply the lessons of others? Again, enjoyed the post.

    Cheers,

    Mark

  12. avatar
    The Passive Income E

    I can't say what's in store but what I am seeing is that the late 20's and early 30's are much more single and for a longer time. It implies they have more disposable income and less to think about supporting a family and the cost of it. Will they save more? or spend more? Which is easier to do?

    In other word,

    – they don't think about saving since they think they have time and want newest shiny gadget.

    – they don't know how much a family will cost if they get there

    – the longer they are in such situation, the longer they can fall for lifestyle inflation

    It takes tremendous effort to go against the grain. What I can say is that retirement will be delayed for many of them.

  13. avatar
    Mike Holman

    Great post, Andrew.

    That WSJ article is a bit nuts – 85% replacement rate? 60 year olds with large mortgages? And they all blame the poor 401(k).

    As for your question, I definitely think that a cost-based retirement income estimate is the way to go.

  14. avatar
    Andrew Hallam

    @My Own Advisor

    Hey Mark,

    Do you mind if I quote your comment….or part of it? I have an idea for another post, and I want to credit you for your eloquent wisdom.

  15. avatar
    Andrew Hallam

    @The Passive Income Earner

    Hey Passive,

    You brought up some points that I haven't thought of before. The longer a person remains without a family (children) the longer they'll have a lifestyle of freedom and…status associated accessories. I think you're absolutely right with that surmise. Once you establish a high lifestyle, it's tough to go back, even when logic suggests you should with children adding to costs…..and credit bills left ignored. So the next generation could have a much tougher time.

  16. avatar
    Andrew Hallam

    @Mike Holman

    Hey Mike,

    Thanks for the comment. It has me wondering about something. As most of our communications online have been with financial bloggers, perhaps we aren't an accurate cross section. I mean, we have all agreed, so far, that calculations of this nature shouldn't depend on an "amount needed" that's associated with income. But as people interested in money, perhaps we represent the vast minority. If this was a blog for dog lovers (or any random blog group) I wonder if they would think we were the crazy ones. After all, perhaps the average person spends everything they make. So the thought of living off 85% of that might be enough to give them a coronary.

  17. avatar
    My Own Advisor

    Of course Andrew; I didn't think I was that wise ;)

  18. avatar
    Kevin@InvestItWisely

    There is something almost tragic in learning from the mistakes of others — I think back to what it must have been like when we lived in tribes and didn't know which plants and herbs were safe to eat and which ones weren't. The wrong choice could quite literally mean death for someone, but by learning from that mistake, the rest of the tribe would now know never to eat that plant again. This is how we grow and hopefully learn not to repeat the same mistakes again.

  19. avatar
    Andrew Hallam

    @Kevin@InvestItWisely

    You're absolutely right Kevin. Leave it to you to bring this to a primal example! I love it! Incidentally, how's the primal excercising coming? I loved that post you did on it a number of months back.

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