News of pension funds facing challenges to deliver income to policyholders have become more frequent in recent years. Consequently, many people have taken matters in their own hands. As such, private pensions have grown in popularity. But what is the right amount of retirement income to strive for? Should we aim for a million, or perhaps more? I don’t think so.
Lifestyle maths
By investing relatively small sums of money on a consistent basis throughout our working life, we can build a retirement pot of a million. This is thanks to the power of compounding. The maths is straightforward.
With an initial balance of £1,000 and a monthly investment of £200, at an annual rate of interest of 10%, a person starting this process at their 20th birthday will have over £1,000,000 by the time they are 60.
Longevity has increased over the years. Therefore, retiring at 60 should provide one with another two or three decades of living on one’s own terms.
But do we need to aim for a million? It depends on our lifestyle. Ultimately, what makes one rich or poor is not how much one earns but how much one spends. I remember an anecdote from a few years ago that helps to illustrate this point.
In a newsletter, Professor Scott Galloway from the New York University Stern School of Business explained how one of his rich friends was poorer than his retired parents. This person was spending all his monthly income, barely having a few dollars to save. Meanwhile, Galloway’s parents were left with a few thousand dollars despite receiving far less money.
What made the difference was not the size of the income, but their lifestyle choices. To live well in retirement is less dependent on the size of our pension and more on our spending habits.
Spend smartly to retire well
Long-term investors cherish the wealth they manage to build over the years. They know how hard it is to save each month, find attractive opportunities and then successfully ride many market cycles.
I believe that the same discipline should transpire once we reach our goal of having some decent income in retirement.
The common image of retirement is often one of yachts and luxurious travels. We are encouraged to see ourselves decorating our property with expensive items and spending money without a worry.
But this is not realistic, nor is it in line with the discipline of long-term investing. Cheap but meaningful pleasures, such as reading, cooking, woodworking, gardening and hiking can make our lives rich once we leave the workforce.
The pensions industry is undergoing tremendous change. These transformations, however, may not be enough to deal with the so-called “pensions time bomb”. We must also calibrate our spending habits in order to live well in retirement.
