The Truth About Retirement’s “3-Legged Stool”

For decades, financial planners have used the analogy of the three-legged stool to illustrate the three principal sources of funds most of us will have available to support our retirements: Social Security, work-based pensions, and personal savings.

The basic strategy offered up by the financial industry to ensure we never run out of money can be described as follows: Before retirement save like crazy; work as long as we can to delay retirement; after retirement, slash spending.

At least that’s my takeaway from a recent Merrill Lynch study of the financial preparedness of various generations for retirement, from baby boomers to millennial. It references this classic three-legged stool, noting that almost no one gets a pension anymore. From the start the study observes:

“Preparing for and funding retirement is more than ever a personal responsibility, and many Americans are worried that a financially secure retirement may be out of reach.”

n other words, a secure financial retirement is in reach if only we take responsibility and save early and adequately. They then offer up this nugget from the survey results:

“While respondents report that they should be saving 25.3% of their income for retirement, in fact they are only saving 5.5%.”

The truth is that most of us don’t save enough because we have competing needs throughout life: pay off college debt, buy a home, raise children (increasingly including college), illness of a family member, loss of a job. The miracle is that we find a way to save even 5.5%.

There’s a reason financial planners pay so much attention to this particular leg of the stool: if we focus rigorously on saving, delay retirement, and cut spending to the bone thereafter, we will maximize our savings—and financial advisors make their money on how much of our money they are managing for how long.

I have nothing against financial advisors—on the contrary. If we have some savings and either lack the expertise to manage it or don’t want to take the time to do so, those are the folks we can turn to for this service.

Merrill Lynch’s study suggests that Social Security will provide an ever-decreasing share of retirement funding. After noting that the “Silent Generation” relies on their benefits for half or more of their income, they introduce this observation based on the survey:

“Each younger generation in turn anticipates less reliance on government programs and employer pensions, and more on personal sources.”

But this sentence is seriously misleading. Younger generations may “anticipate less reliance on government programs,” but that doesn’t make it so.

It’s no surprise people have low confidence in Social Security, given how politicians of both stripes keep shrieking that the program is going broke. But whenever I speak with audiences of all ages, I have no problem convincing (almost) all of them that the fix for any future shortfall is fairly painless and that in fact the benefit amounts get better and better for younger generations.

In other words, Social Security will be more and more the foundation of our retirements. This leg of retirement’s three-legged stool isn’t going anywhere.

Here’s a little-known fact about Social Security: not only will the benefits be there for future generations, but the benefit amounts will be substantially higher in constant dollars (income adjusted for inflation). Why? Because our benefits are based on average wages around the time we reach retirement age. Since average wages go up steadily over the decades, this results in higher benefits.

My father and I had roughly comparable lifetime earnings adjusted for inflation; my benefits will be over 50% higher than his were. In other words, benefits are roughly doubling over two generations. What was a more modest retirement benefit for my father will be a much more substantial one for me and even more so for my children.

Most financial advisors continue their mantra of work-save, work-save to accumulate enough savings for our retirement. While most of us put away some savings, it’s not nearly enough for our advisors.

There’s a better alternative that you are not likely to hear from many financial advisors: Find out where you might live in luxury and style on your age 70 Social Security benefit—the world is full of such magical locales where your U.S. dollars can go so much further—then find a mix of spending from your savings or other sources of income to support your lifestyle until you reach 70. That’s putting your savings to work for you, not your financial advisor.

Cutting Small Expenses Can Make You Rich

Cut your expenses and that should be the mantra you should adhere to. It is not what you make but what you spend. Yes, we all want to make big bucks as quickly as possible and retire early but that is not always possible, unless you happen to win a lottery and become rich overnight. Can you believe that 70% American are living from paycheck to paycheck? You might think that those little small things you are spending money on every day are not worth considering and it is prudent to concentrate on big ticket items. But my friend, you are wrong.

Have you ever heard of the Latte factor? It is the money you spend on small items every day that add up to a considerable chunk at the end of the year. Invested wisely, that money can grow to your wildest imagination. I am not suggesting that you give up your favorite coffee and spend your day miserably. But you can certainly find small items here and there that you spend money regularly and cut the expenses on those items, let us say, 50%.

Start an expense book and write down every penny you spend everyday for one month. At the end of the month, add up all the small items, like coffee, candy, snacks, muffin, power drinks, power bar, etc. Unless you are one of those prudent money savers, you will be really surprised at how much you have spent over a 30 day period. Now, here is what you need to do. Budget your coming month’s small item expenses at half the level you spent in the last 30 days. At the start of the month, Take 50% of the money you spent on small items in the last 30 days and put it in a newly created savings account. Do it for one year and at the end of the year, take the money and buy some index fund.

Besides saving on small items, you should also have a monthly savings from your 401K, if your employer is offering one. It will save you big on taxes till you retire and start withdrawing money from it. If your employer is matching your 401K contribution up to certain percentages, it will be like throwing away money of you are not taking advantage of that match.