The traditional approach to saving for retirement is all about starting early, saving consistently, and letting compounding growth do most of the heavy lifting over time.
Yet the reality is that for those who are still early in their careers, there really may not be enough income coming in to save in the first place. It’s only as income rises that savings behaviors really start to matter. And for those who have saved long enough, eventually the impact of savings is muted by the sheer size of the portfolio, as compounding growth becomes the driving factor in reaching retirement success. Until the retirement date actually looms close, and then preserving the portfolio for the retirement transition is more important than just trying to maximize growth.
In fact, this framework of Earn, Save, Grow, and Preserve can be a helpful way to think about the progression of accumulating for retirement. Each phase has its own unique issues to be navigated, and success in one phase leads to the challenges of the next.
Most importantly, though, considering the four phases of saving and investing for retirement is crucial to ensuring that the retirement advice being delivered is relevant in the first place. After all, focusing on strategies to maximize portfolio growth are irrelevant for those who can’t afford to save yet, and for those with a large retirement portfolio, ongoing contributions become irrelevant and the focus must be on growing and preserving the nest egg instead!
Conventional View Of Saving And Investing For Retirement
The conventional view of saving and investing for retirement holds a consistent series of core tenets:
- Spend less than you make
- Automate your savings strategy (“pay yourself first”)
- Maintain a healthy exposure to equities for long-term growth
- Maintain a diversified portfolio to manage your risk
In turn, this leads to a relatively straightforward retirement savings strategies of “start early, save consistently, and let compounding growth work for you over time.” After all, it takes just $300/month of savings from age 25 to 65 to accumulate a $1,000,000 nest egg (assuming an 8% growth rate over time).
The Four Phases Of Saving And Investing For Retirement
The caveat to the traditional view on accumulating for retirement is that in reality, an individual’s income, spending, and ability to save vary greatly throughout life. From the impact of raises and promotions (especially significant in the early years of a career), to starting a family (and then moving on to the empty nest phase later), steady saving for retirement is not necessarily as feasible as the conventional view would suggest.
Similarly, the reality is that the importance of investment returns and risk management vary over time as well. Those still in the early years of accumulation have such a long time horizon, they still have the capacity to take significant risk in the portfolio, while in the later years an adverse market event could drastically derail a retirement plan and the planned retirement date. And the simple truth is that in the early years, the actual dollar amount of growth is so small, it’s often dwarfed by ongoing contributions; it’s only in the later years that growth becomes the real engine driving the portfolio to the retirement finish line.
In other words, accumulators progressing towards retirement will actually go through phases that have distinct challenges. After all, focusing on whether you Save isn’t relevant until you’re Earning enough to save. And success in the Saving behavior itself eventually creates a portfolio large enough that the Growth is what matters the most. And years of compounding Growth is what closes the gap on retirement, bringing the retirement date closer but also accentuating the need to Preserve the portfolio and manage the retirement date risk.
Thus, over time an accumulator will need to navigate each of these four distinct phases in turn: Earn, Save, Grow, and Preserve.
Earn: CAN YOU Save For Retirement?
In the first stage of saving for retirement, the driving issue is simply whether you earn enough that you can afford to save or not. In other words, does your income exceed your expenses, such that there is something left over to save in the first place?
Of course, the reality is that at virtually any income level, there will be a group of people who spend more than they make, and can’t seem to find any available dollars to save. But for prospective savers in their early working years, who may still only be earning minimum wage, they really may not be earning enough yet to have any material dollars left over to save, after covering just the basic household essentials (food, shelter, and clothing). Or perhaps they are earning slightly more than minimum wage, but are burdened by student loan or other debt payments that leave little cash flow available for saving.
For people facing this situation, the ‘traditional’ advice to spend less and save more isn’t very effective, because there really isn’t much of any spending to cut in order to spend less. Instead, the real path to financial success from here is not to spend less and save more, but to earn more to save more.
In other words, the key issue for those in Earn stage of saving for retirement is to figure out how to increase their income earnings so they can save in the first place. That could be figuring out a side hustle for some extra income, or reinvesting any available dollars (if there are any!?) into a course or training to improve the career trajectory, or even just coaching on how to ask for a raise.
But again, the fundamental point is that early on, the best advice to save more for retirement is to earn more so you can save in the first place!
Save: ARE YOU Saving For Retirement?
As income begins to rise during the early working career, suddenly a prospective saver may reach the point where there’s enough income to cover the bills (and outstanding debts) with something left over. So what do you do with the extra income? At this stage, it’s no longer a question of the sheer capacity to save, but instead about taking action to save, or whether that extra income is spent instead.
Certainly, one of the great ‘joys’ of generating additional income is the opportunity to spend it on the pleasures of life, but allowing the lifestyle to creep higher every time there’s a raise means no saving will ever actually get done. At some point, it’s necessary to actually commit that not all of the next raise will be consumed, and instead that some of it will be saved, instead.
Of course, the temptation to spend more is everpresent, and lifestyle creep is called that precisely because it tends to “creep up” slowly and steadily without realizing it… until the realization comes that income has significantly risen and there’s still no money left over to save at the end of the month!
Accordingly, success in this stage of retirement savings is all about managing spending and saving behavior to actually facilitate saving. Whether it’s automating savings behaviors, or finding other ways to “pay yourself first”, or committing to “Save More Tomorrow”, or trying to actually cut spending to free up more money to save, the outcomes will be driven not by the financial capacity to save, but the behavioral ability to reign in lifestyle choices and direct free cash flow to savings instead.
Grow: How Much Is Your Retirement Nest Egg GROWING?
As savings behaviors are cemented into place, and fuel a rising balance for the retirement nest egg, eventually the portfolio becomes so large that each incremental contribution no longer has a significant impact.
For instance, saving $300/month allows an account balance to grow to $3,600 by the end of the first year. In the second year, the account may grow slightly, but the increase in the account balance will again be driven primarily by the contributions (as a year’s worth of growth may still be less than a single month’s worth of contributions). After 10 years of the same behavior, though, suddenly only half of the annual increase in the account balance is driven by new contributions, while the remainder is driven by growth on the existing balance. After 20 years, growth will drive 75% of the annual increases in the account balance. After 30 years, it’s almost 90%.
This shifting dynamic means that after a decade or two of ongoing contributions, the greatest driver of the outcome isn’t the spending behavior and ongoing contributions anymore; now it’s the ability to grow the portfolio, and the returns being generated.
In turn, this means that as the portfolio grows, paying attention to how it’s invested begins to matter, a lot. In the early years, improving returns by 1%/year still has a trivial impact compared to saving another $100/month. In the later years, adding 1%/year to returns is highly material.
Accordingly, in the Grow phase, it becomes necessary to really look at the portfolio itself. Is it properly invested for growth? Is there a reasonable asset allocation? If investment/fund managers are being used, are they really providing value for their cost? And are the portfolio costs being managed overall, given the dramatic impact they have on long-term returns?
The bottom line: in the Grow phase, paying attention to the finer point details of how the portfolio is invested can really begin to pay off (for the first time).
Preserve: Are You MANAGING THE RISK As Retirement Approaches?
As the planned date of retirement draws near, the dynamics shift once again, as the shortening time horizon becomes highly relevant. Suddenly, as the portfolio reaches its largest value, contributions are dwarfed by the portfolio volatility, and the risk of a severe bear market in the final years (and the time it would take to recover) can substantially derail the planned retirement date. In other words, Preserving the portfolio and managing the risk becomes the dominating factor for success.
Of course, the reality is that retirement itself can entail a multi-decade time horizon, so it’s not feasible to eliminate all portfolio risk. Nonetheless, as the retirement date approaches, preserving the portfolio and managing “retirement date risk” is increasingly relevant, as if a market decline occurs, savings alone can no longer make up the difference.
In point of fact, target date funds already engage in this strategy, with an “equity glidepath” that decreases in the final years to preserve the portfolio as retirement approaches. And many variable annuities with “living benefit” riders (e.g., GMWB or GMIB riders) are used for a similar purpose in the final accumulation years. In theory, even a simple strategy of buying out-of-the-money puts to preserve the portfolio by hedging the magnitude of any downside risk in the final years could be effective (akin to how many structured notes are put together).
Nonetheless, by whatever means, the key issue for a prospective retiree in the final years leading up to retirement is less about generating growth, or making ongoing contributions, and is more about sustaining moderate growth while also Preserving the portfolio to manage the looming retirement date risk exposure.
Progressing Through The Four Phases Of Retirement Accumulation
A successful accumulator who is “on track” for retirement from their early 20s through their mid 60s might spend most of their 20s just trying to improve their earnings enough to save, would focus on sustaining their savings (and avoiding lifestyle creep) in their 30s and early 40s, allow compounding growth to work for them through the rest of their 40s and 50s, and start considering the risk management issues as they approach their 60s and the retirement transition looms. In other words, the Earn, Save, Grow, and Preserve phases will come sequentially over time, as success in each leads to the next.
Of course, for an accumulator who is not on track for retirement, their progression through the phases may not align with the ages noted above. Nonetheless, from the perspective of achieving retirement success, the fundamental point is that the “right” advice for an accumulator depends on which phase they’re in. Giving advice focused on the later stages of growth and preservation is largely irrelevant to someone still in the Earn or Save phases, just as focusing on earning more or saving more is not very relevant for someone in the preserve stage leading up to the retirement transition (where the portfolio is so large that incremental earnings and savings won’t have much impact anyway).
Ultimately, though, the point is simply that effective advice for retirement accumulators will vary over time. In the Earn phase, it’s all about increasing your income so that you can save. The Save phase focuses on savings (and spending) behavior. The Grow phase is where the portfolio’s investment strategies matter. And the Preserve phase is about managing the upcoming retirement transition. For retirement advice to be effective, it must be paired to the appropriate phase.
So what do you think? Does the “Earn, Save, Grow, Preserve” framework seem like a relevant way to discuss accumulating for retirement, to focus in on the right issues for the retirement accumulator? Are there any gaps in this approach? Please share your thoughts in the comments below!