It used to be a considered something of a tawdry question, although it could be flattering as well: “What’s your number?” Nowadays, your inquisitor is probably asking about retirement – as in, how much you think you need to retire. And, as it often was before, it’s the wrong question.
Is your number US$5 million (S$6.5 million)? US$1 million? US$50,000? No one seems to know how much they’ll need, but whatever they think, they’re probably not on track to save it. That confusion is unsurprising, because a number cannot reveal if you are on track for retirement.
Of course, it’s better to have more money than less. But a “magic number” is meaningless. It is good to have financial goals, and to work towards them, but a wealth goal is counterproductive.
The aim shouldn’t be to attain a certain level of wealth by a specific date, but to assure yourself of a steady level of income throughout your retirement. These are fundamentally different objectives, and they require a different investment strategy and mindset from the start.
Magic-number goals tend to be independent from any investment strategy. Do you move into bonds or some other low-risk strategy once you hit your number to make sure you maintain it? Most people stay in target-date funds, which are invested mostly in stocks even into retirement.
A magic number also does not tell you how much you can spend each month. Maybe you withdraw 4 per cent a year, but without a strategy to hedge against risk, your income will vary each year. Or, if there are several years of bad returns, even your magic number might not be enough.
The goal of retirement investing is not to have a pile of money on the day you retire. It is consistent income throughout your retirement. You can achieve this through a number of methods.
You can buy an annuity. You can buy lots of long-dated bonds that make regular (inflation-adjusted) payments each year. You can finance your necessary expenses with bonds or an annuity and take on some extra risk to finance more discretionary spending, like travel.
The point is that all these goals have to do with income, not wealth. Annuity and long-term bond prices also move around a lot, not always in a way that has a predictable correlation with a portfolio of stocks and short-term bonds (which is how most retirement savers are invested).
This creates what’s known as a duration mismatch: Your wealth does not provide enough income for you to retire how you want to. If you decide to switch from a wealth to income strategy on a day when the market happens to be up, for example, the prices of bonds could provide you with far less income than you expect.
This mismatch can have a big impact on your retirement. The figure below shows how much 20 years of income (inflation protected) US$1,000,000 would buy you each month over the last six years. If you converted US$1,000,000 into an income strategy in 2016, you’d get US$53,000 a year of income; in 2020, only US$47,000; and if you did the same this year, you’d have locked in US$65,000.
Managing this risk requires investing for income much earlier than the day you retire. That could mean investing in long-term bonds or including an option to annuitise at a certain price in your portfolio. If you focus on a number, however, you’re likely to suffer from a mismatch. That’s because you’re maximising the wrong thing – wealth instead of income.
This is why all this obsessing about a “magic number” is so pernicious. It focuses savers on wealth when what they really need is income. It exposes them to unnecessary financial risk throughout retirement and makes it harder for them to know how much they can spend when they do eventually retire.
So the next time you’re at a bar or a party and someone asks you for your number, don’t be shy. Use the question as an opportunity to educate them about retirement planning.
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Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is the author of An Economist Walks Into A Brothel: And Other Unexpected Places To Understand Risk.
