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A guide to retiring rich
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July 3, 2001: 6:25 a.m. ET
The earlier you save the better, but it's never too late to begin
By Walter Updegrave
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NEW YORK (Money.com) - You've likely heard the frightening statistics suggesting that only a handful of people in the United States are saving enough to enjoy a decent retirement. Then you read those stories to find that if you didn't start saving half your income in your 20s, you'll never catch up. No wonder you're discouraged.
The truth is, it's not that hard. No matter where you are today, there is something you can do to build a nest egg. In fact, we've funneled all the retirement planning noise into five simple steps. Master these, and your golden years will be gilded indeed.
1. Start early ... but don't panic if you start late.
The most important advice can be summed up in one sentence: Save as much as you can as early as you can. The sooner you start, the more time the power of compounding can work its magic.
Say between ages 30 and 40 you invest $10,000 a year in a 401(k) in such a way that it earns an eminently achievable 10 percent average annual return. Then you stop investing. By the time you turn 65, your investment will have grown to more than $1.7 million. But had you not begun saving until age 40, your 401(k) balance at age 65 would total less than $700,000.
Of course, life can derail our best intentions. But no matter where you are today, there's always something you can do to improve your situation. Even if you're savings-free at 55 and can manage to invest $5,000 a year in a tax-deferred plan earning a 12 percent average annual return, you'd have almost $90,000 by age 65. Leave that sum invested another five years--say, by postponing retirement--and it grows to more than $150,000. Granted, that won't fund a luxurious retirement, but it's preferable to living on Social Security alone.
(Click here for a look at the most common pitfalls that can derail your plans.)
2. Base your planning on your life.
Many of us will spend at least one third of our lives in retirement, so you'd think we'd base our plans on the facts. But nooooo. Instead, we rely on guesstimates and rules of thumb.
Take the "70 percent rule," which contends that because work-related expenses and the need to save for retirement disappear after you retire, you can maintain your present standard of living with less than your current income. The problem with the 70 percent rule is that it's wrong 90 percent of the time. Why? Because it's an average! It reflects the earning and spending experiences of tens of thousands of people, not you. You should make your decisions based on your resources and needs, not averages.
What you'll need in retirement depends not on what you spend now, but what you spend then. If you've paid off your mortgage, are in excellent health, and plan to document the mating habits of the cecropia moths in your garden, chances are you can get by with much less than 70 percent of your income. But if you plan to keep a country house, a beach house, and a pied a terre in town while globetrotting in first-class splendor, you'll probably need more than 100 percent.
Once you've set your goal, you can determine how you'll get there. In most cases, that means relying on Social Security, pensions and your investments. For help planning, try Money.com's retirement savings calculator.
3. Go for growth ... but diversify, too.
Stocks deserve a starring role in almost everyone's retirement portfolio. In the past seven decades, the large-company stocks in such indexes as the S&P 500 have returned 11.3 percent a year on average, more than twice the 5.2 percent average return on government bonds.
But stocks can take some chilling spills along the way. Flash back to 1968, and imagine you had retired at 60 with a $500,000 tax-deferred, all-stock portfolio. You planned to withdraw 6 percent, or $30,000, of your portfolio's balance the first year then increase that withdrawal by 3 percent each year to keep pace with inflation.
Based on history, you could expect a comfortable retirement. But the market tanked. During the1973-74 bear market, the S&P 500 dropped 48 percent in 21 months. The market recovered, of course. But for people about to retire or those living off their portfolio income, that loss was devastating.
(Click here for a look at stocks and funds that perform well in all market conditions.)
Bottom line, you need to balance getting high returns with protecting your portfolio from gut-wrenching losses. Asset allocation is the way to do so.
Allocation simply means placing your money in a mix of stocks, bonds and cash appropriate to your age and risk tolerance. By diversifying, you hedge your bets so that when one part of your portfolio is getting hammered, another part is gaining--or at least is not getting clobbered as badly. If the 1970s bear market had hit you just after retirement, but you had invested 75 percent of your money in stocks and 25 percent in bonds, your bonds would have been a shock absorber. Your portfolio would still be going strong more than 30 years later with over $200,000.
Once you determine the best split of stocks and bonds for you, tweak your allocation to include a mix of large-cap and small-cap stocks, growth and value stocks, international and domestic stocks, as well as different classes of bonds. For help, use Money.com's asset allocation tool.
4. Max out tax-advantaged savings plans.
There are few free lunches. But that's what you get with tax-advantaged retirement accounts such as 401(k)s, IRAs, 403(b)s and Keoghs. Each offers tax breaks and other perks that can supersize your savings.
Take 401(k)s, the most lucrative of the bunch. They give you three big benefits: 1) an immediate tax break since the money you put into the plan is deducted from your salary and goes untaxed until you withdraw it; 2) tax-deferred growth since all gains compound tax-free until you pull them out; and 3) a possible matching contribution from your employer. The average employer match is 50 percent of the first 6 percent of salary you contribute.
Those benefits add up fast. If you're in the 31 percent combined federal and state tax bracket and you invest 6 percent of a $70,000 salary in a 401(k) with a 50 percent match, your annual investment totals $6,300 (your $4,200 plus your employer's $2,100). You also enjoy tax savings of $1,302 (31 percent X $4,200). That means your employer and Uncle Sam are kicking in $3,402 -- or more than half -- of that year's $6,300 contribution. It also means you get an 81 percent return on your $4,200 expense.
5. Improvise.
The road to retirement has lots of twists and turns. You can increase your chance of success if you stick to the basics, then make adjustments as circumstances change.
When building a career and raising a family, there may be years you can't max out your 401(k) or other savings. There also will be years when you come into unexpected cash--a big raise or an inheritance. Take advantage of such occasions to jack up your savings.
Even if you're on the verge of retiring, you still can enhance your quality of life. Pare back on unnecessary expenses. Invest part of your holdings somewhat more aggressively in hopes of a bigger return. Take out a reverse mortgage on your home for a tax-free monthly income. Or join the increasing number of retirees whose vision of retirement includes holding some sort of a job. If you're really short on savings, you might even consider moving to an area where low living costs can stretch your income and extend the life of your retirement portfolio. 
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