The Risks of Not Saving & Investing
There are four major risks of not saving adequately for your future needs and goals:
- The likelihood of Social Security benefits not providing adequate money for a long-term, post-retirement lifestyle
- That your life expectancy will outpace your savings
- The possibility of a major unexpected life or economic event
- The impact of inflation on your savings
When thinking about retirement, too many people think that Social Security payments will be the key to their financial security. It's true that most likely this government program will continue to make up a portion of most retirees' annual income. But the reality is that Social Security will provide a smaller amount of money than most people anticipate. The three factors that will determine how much Social Security you'll receive are:
- The number of years you work and pay taxes
- The amount of your annual earnings (which will be adjusted for inflation).
- How old you are when you start receiving benefits (be aware that the minimum age you can begin drawing full Social Security benefits will be 67 for anyone born in or after 1960.)
To make a long story short, if you're decades away from retirement, you should plan on receiving less money at a later age than you may have previously thought. A typical worker earning $50,000 and retiring at the age of 65 is receiving about $16,000 from Social Security annually, less than a third of pre-retirement earnings. You as the retiree must make up the difference between Social Security and the amount you'll need from other sources.
You (or your spouse) may be lucky enough to have a fixed pension from your job that will make a big difference. But, increasingly, employers who provide pensions are making defined contributions to a tax-deferred account rather than promising a fixed amount. It's up to you to invest this money wisely and to add personal savings to any tax-deferred plan (like a 401(k)) that is available or save and invest for retirement on your own.
To get a copy of your personal Social Security Statement, which will include an estimate of how much you're entitled to receive in benefits and when, go to the Social Security Administration's website. Learn more about how to plan, save and invest for your post-work life through our Retirement section.
Most Americans begin their careers around the age of 21 and expect to retire at age 65. Although there's obviously no way to guarantee your personal life expectancy, when planning your finances it's helpful to realize that many Americans are living to be 85 or 90. That means you may have to save and invest enough money to support yourself for an additional 20-25 years after retirement. That's almost half the time you spend earning money in the first place! A good way of thinking about saving is that for every two years you work you'll need to save enough to provide for one year of retirement income.
Unexpected Major Life or Economic Events
Would you be prepared to financially weather a sudden life event like the loss of a spouse, the loss of a job, a long illness or the loss of your home due to a natural disaster? Would you have money saved to continue paying bills and making ends meet if you lost some or all of your income, or if you accumulated enormous unexpected expenses? What would you do if the economy or markets took a downturn, and your retirement or pension plan holdings or your house lost value?
Without savings or investments and a plan to go forward, an unexpected life change can force you to quickly make difficult decisions such as whether or not to:
- take out personal loans
- take on significant, potentially high-interest credit card debt
- take a second job, go back to work or find additional types of employment to supplement your income
- delay important personal goals
- sell key possessions such as a home on which you can no longer afford to make payments
Unfortunately all too often one significant event – a family member who is uninsured or underinsured having a medical emergency, the loss of a job or a spouse, an injury on the job or a car accident – can begin a rapid spiral into a lot of debt that may have significant long-term consequences, including potential bankruptcy. Having at least enough money saved to meet 6 months of living expenses in the event of an emergency will give you more financial ability and flexibility to try to meet the immediate financial challenges of this sudden life change. It will also help you reduce or avoid having to take on debt to help manage the crisis, which may lessen the financial impact on you or your family at a very difficult time.
The fact that markets and the economy do not always go up – as witnessed by the most recent recessions in 2001 and 2008-09 - is an additional reminder of the value of having a saving and investing plan and of continuing to save and invest from an early age.
The dreaded “I” word – inflation. With inflation running at only about 3 percent over the last century, it's easy to dismiss as the financial equivalent of fearing monsters under the bed. But don't let that little number fool you. Just like compounding, the cumulative impact of even low rates of inflation over time can have a substantial effect. In this case, inflation can substantially erode your savings. Let's look at an example. Say you have a savings account with your local bank paying 3 percent interest annually. If you've set aside $2,500 a year for 25 years, you'll have socked away $62,500 of your own money, which would grow to $92,900. Before you get too excited about the effect compounding will have on your savings, let's factor in 4 percent annual inflation. Now that total investment drops to the equivalent of only $55,575 after inflation.
Don't lose heart – because inflation is inevitable you can plan for it and compensate accordingly. When coming up with a long-run saving and investing plan, a good rule of thumb is to add in an additional 4 percent annually to cover the cost of inflation.