According to Fidelity, we need 80% of our current income to retire (see Canadian Capitalist’s “Fidelity’s ‘Scary’ Retirement Findings“, where I found this story). Canadians on average have 50% of their pre-retirement income in retirement, but this is no different from other countries; United States: 58%, Britain: 50%, Germany; 56%, Japan: 47% (see “Want to play in retirement? Test your future income“). If those numbers are not adequate, it implies that the average senior in the United States, Britain, Germany, and Japan are all in dire need. I doubt that is the case. (My opinion is that people should save as much as they want. You might need only 50% but if you want to spend a lot in retirement and travel instead of just tinkering in your garden then maybe you need 80% of your pre-retirement income, or maybe 150%, just in case.)
The funny part is that even if you wanted to get to 80%, the hardest way to get there would be to use Fidelity’s products. All their MERs are above 2% (click on Facts & codes). It’s too bad their retirement calculator doesn’t have a slider bar for the MER or rate of return, then you would be able to see just how badly these management expense fees can affect the final value of your portfolio, and in turn, your annual income in retirement.
I just did a calculation and if you invest $8,500 annually starting from the age of 30 you end up with $2 million at the age of 65 if the contributions are indexed to inflation and the rate of return is 8% (the return you might get if you buy a low-MER (0.25%) investment, like an index ETF). Decrease that return to 5.75% (the return you’ll get if you pay a 2.5% MER on Fidelity mutual funds or their managed portfolios) and you’ll have only $1.32 million at age 65. Assuming $2.64 million is what one would need to keep the same income one enjoyed pre-retirement:
In the 2.5% MER case: $1.32 million is 50% of $2.64 million
In the 0.25% MER case: $2 million is 76% of $2.64 million.
So by simply not using a company like Fidelity and going with a competitor like Vanguard or iShares and buying index ETFs (with far lower MERs) instead, you can easily get closer to that 80% figure and increase your nest egg from to $2 million from $1.32 million without even having to save any more money. By the same token, it could probably be argued that one of the main reasons that Canadians do not have 70-80% of their pre-retirement income in retirement (and only have 50% instead) is because of the amount of MERs, fees, and commissions they pay every year to the financial industry.
Should Retirement Replacement Ratio be 50%, 80% or in between?
5 thoughts on “Fidelity Says You Need 80% Pre-Retirement Income in Retirement (just don’t use them to get you there)”
There are two things everybody seems to overlook in these “replacement ratio” debates:
1) There is a huge difference between your gross and net pre-retirement income. There are many things deducted from the paycheques of working Canadians that retirees simply don’t have to pay (i.e. CPP, EI, union dues, pension plan contributions, professional dues etc). Those costs can easily eat up around 10% (or more) of gross income. When you’re retired, these costs are gone, so your gross income can be that much lower with absolutely no change in disposable income or lifestyle.
2) Income doesn’t matter. At all. Expenses matter. If you know what your expenses are, and what you want them to be in retirement, it’s pretty easy to calculate how much you’ll need. If you want to live the “high life” in retirement, your expenses will be that much higher. Most people when they retire, though, live a lifestyle very similar to the one they lived while working.
George: You’re absolutely right. It’s not just the working expenses. In retirement, some of life’s major expenses such as mortgage payments, daycare/childcare expenses etc. also goes down. And yes, how much we spend is all that matters and we need enough savings to cover that.
Dave: Expenses are one enemy of the investor. The other is emotions. Arguably, investors lose more to chasing returns, panic selling etc. So, we have to keep expenses and emotions in check to earn close to market returns.
There is no dispute that some percentage is the right one for someone. But putting an exact number can be incredibly difficult. I submitted a post today about an often under-considered part of any retirement plan: your health. No doubt, this is the easiest to control aspect of your retirement plan and the most overlooked. It is the one place where taking the most conservative risk is the best investment.
George and CC make an excellent point with regards to expenses.
I imagine that your average Joe’s biggest monthly expense is housing, which tends to take up about 30% of income. If you manages to pay off your mortgage by age of retirement, you only need to save enough to cover the remaining 70% of your pre-retirement income. If we start considering the other factors George highlighted, one quickly sees that Fidelity’s estimate is somewhat inflated – which shouldn’t surprise us, given that the more we save, the more money Fidelity makes.
I use Quicken to keep track of my finances, and I’ve created a report that I call my “estimated retirement expenses”. It’s a tally of all of our expenses over the past 12 months, minus the ones that won’t exist when we’ll be retired (day care expenses, mortgage payments, etc). This gives me a rough idea of how much after-tax income will be necessary to maintain our standard of living in retirement. It doesn’t account for increased expenses in retirement, such as travel or medical care, but it provides a really good baseline to work with, and it provides me with a personal estimate of the “replacement ratio” that will apply to me.
The expenses in the above report represent about 35% of our household gross income, or about 45% of our current take-home pay. Even adding in a healthy margin for travel and medical expenses, our “replacement ratio” shouldn’t exceed 55% – far from the 80% recommended by Fidelity.