Every Thursday we grab a cup o’ Joe and talk opinions on financial matters…..today we’ll chat about goal setting and workplace retirement plans.
My opinion: Do you know those 401k asset allocation charts in the front/back/middle of your workplace retirement plan booklet? They’re color coded circles of slick graphics, and are often found at the conclusion of a survey about the amount of risk you should take in your investments.
Those pie charts are nearly irrelevant when it comes to financial success.
Each day in a workplace somewhere in America you’ll find a fast-talking 401k-hocking yahoo teaching a group of people how to use these silly charts to determine how much risk they “want” to take.
How much risk you “want” to take?
“Want” and “financial success” rarely coexist when talking about money management. Most people want zero risk and huge returns. They also want Santa Claus to be a little more kind next year than last.
Is “how much risk do you want” really the question you should be asking with your 401k plan?
I have a better question.
Try this one on: How much risk do you need to take to reach your goal?
Isn’t that the question these surveys should be asking?
I know this doesn’t sound like rocket science, yet you’d think so if you’ve ever read workplace retirement plan guides. In many cases, risk tolerance charts and savings guidelines are presented as two entirely different discussions.
Let’s be clear about what I’m discussing here. If you’re going to achieve financial success:
Find out how much you need to save.
Then learn what return you need on that savings.
If I had control of these workplace pie charts, here’s what I’d do
I’d gather everyone in the conference room and show the group how to determine the amount they need to save to reach financial success. I know that’ll differ for everyone, so it’ll be important to focus on goal calculators. With the boss’s permission, we’d follow this up with generous portions of alcohol. We’ll call it “Some of You Will Be Happy” Hour.
Second, I’d help everyone determine what return they need on that savings to achieve the retirement goal.
Sounds like I’m repeating myself, doesn’t it? I’m not.
Here’s where we finally insert the silly quiz
Third, the employees would be presented with the risk tolerance quiz. Everyone could see if the asset mix they (historically) would have needed to reach financial success matches their risk tolerance.
If so, more Happy Hour.
If it doesn’t: Houston, we have a problem.
The real problem
If you aren’t going to reach your goal, you have a choice to make: either save more money or raise your risk tolerance. One requires sweat, the other education.
Which path would you follow?
I believe that once we begin presenting 401k plans this way, instead of with some inane chart about your “risk tolerance” (lots of people very comfortably missing their goals out there), we’ll finally begin to realize that every goal can be met through a simple equation:
Savings x Return = Goal
How you approach one side will affect the other.
Emily @ evolvingPF says
I’ve never had a workplace retirement plan so I don’t know exactly the types of meetings you’re referring to, but I totally agree that letting going for “low risk” investments early on is putting your standard of living at risk in retirement.
I’m interested in how to use goal calculators at my stage of life (pre-first real job) – is it possible at all? The ones I see online want to know current salary, yearly raises, etc. Since I don’t have that information I feel like I’m just throwing lots of money at my retirement accounts with no plan (yet) on how they need to shape up.
Average Joe says
You’ve got half of it, Emily! The other half I’ve seen is people who take WAY too much risk just because they think they should. Then disaster hits (2002, 2008) and they get creamed for no reason.
Dr Dean says
Emily, since Joe only half answered your question….You can’t fill in a standard online calculator until you have a stable income, and other parameters the calculator uses to come up with a canned answer….
You should instead look at your income and expenses and life goals and decide if you can put money into a retirement plan at this time and still meet your financial needs monthly. If you can afford the IRA, then you do need to look at risk tolerance as Joe discusses and find a balanced approach you can live with. No spreadsheet or financial calculator will answer that question. (sorry for butting in Joe…)
Average Joe says
I missed most of your comment, Emily, because I was on the road at the time. Hopefully, you’re still following this thread!
Using a goal calculator should be easy, because it shouldn’t take into account what you’re earning now at all. Instead, it should ask what the parameters of the goal would be, then it breaks the goal down into monthly chunks to save.
It’s up to you then to adjust your budget and save the required amount or to create a plan to save more later. Some of the cooler (technical term) calculators will allow you to save less today and show yourself saving more later. That way, you can kind of play with your changing income over time a little.
But…the good news? You don’t need to worry about your income now to go through the calculation, and you WILL know where you’re sitting with respect to your goal.
This was a great question! Sorry I missed it earlier!
I don’t have anything like that but my wife’s is very similar. It’s fun to see how some planners/advisors think similarly.
I’m taking part in that Roth IRA movement next week and I’ve planned an ‘Understanding Retirement’ series with one of the posts being something very similar to this. It’s about starting with the end in mind and using that to help you understand how much you need to save and how much you need to near.
Good stuff as always AJ!
Average Joe says
I can’t wait to read it, because I believe we both think this whole thing is about balance….I want to save for tomorrow but I also want to make sure I’m gonna be okay tomorrow.
Stop writing about Stuffed Mushrooms. You’re driving me crazy with that stuff. I want to eat constantly already without you throwing up awesome mushroom recipes….
Karunesh @ chase-a-dream.com says
How much risk you do want to achieve your goal? How much you can take to achieve your goal? How badly do you want your goal?
These questions help a great deal in coarse correction on our way to our goal. thanks for sharing.
Karunesh @ chase-a-dream.com says
Hi Average Joe,
I have included this post at my website weekly roundup #2
Miss T @ Prairie EcoThrifter says
I too have never had one of these so I can’t really say. I do think though that a plan is really important and no matter where you get it from, you must have one. Not planning is the worst thing you can do. The sooner you get organized, the better off you will be in retirement.
As far as risk goes, I think you need to balance high and low risk opportunities. Just like everything else in life, be balanced. Being at either end of the spectrum never works out well in the long run.