The answers to all those questions have real consequences for your family's financial future, but by the time you know those answers, it's usually too late to do anything about it. That -- more than almost anything else -- is what makes investing difficult. You're committing significant resources now to prepare for future events that may or may not come to pass in a form anywhere near what you're expecting.
Your One Saving Grace
In spite of all that uncertainty, the one key benefit you have is the fact that money is fungible -- once you have it, you can put it toward any legal purpose you want. If your child receives a scholarship, money you had been saving for his or her education can be deployed elsewhere. If your retirement investments substantially outperform your expectations, you can retire earlier or with a better lifestyle.
The key, of course, is to get the money in the first place. It's far easier to put it to a different use than you originally intended once you have it than it is to initially come up with that cash. Even so, we all face tradeoffs -- none of us has an unlimited source of cash, and every dime we invest is a dime we can't use to support our current lifestyle.
Given those tradeoffs and uncertainties, a great approach is to:
- Make your best estimate of things to come, your top priorities and their costs by the time you'll need them.
- Invest your money toward that future, assuming you'll somewhat underperform your targets.
- Adjust your plan along the way as the future unfolds differently than your original plans.
Plan Around That Uncertain Future
The largest expense most people save for is retirement. The four big uncertainties around that are:
- When will you retire? You may want to work until you're 67, but the reality is that more than half the population is out of the labor force by around 64. If you build your plan to enable you to retire three or four years sooner than you'd really like to, it puts you in the driver's seat. If you reach that age and are either forced into early retirement or decide you'd like to leave the rat race, you'll still be OK. And if you reach that age and still find you love working, then you'll still be set to retire on your terms.
- How long will you live? The average life expectancy is around 81 for American women and age 76 for American men. You may live longer or shorter than average depending on key factors like your health, family history and advances in medicine. Make your best estimate, then add a few years to it. After all, it's certainly better to pass away with enough to leave a modest inheritance than it is to run out of money in the later years of your retirement, when you're least able to do anything about it.
- What will your retirement lifestyle cost? A reasonable way to estimate your costs of living in retirement is to assume that they will be about what they were before you retired. On one hand, the costs of working go away when you retire, your mortgage goes away once your house is paid off, and your costs of raising your kids stop once they move out. On the other hand, your baseline costs of living will probably go up as you age, as you may start hiring help to handle things you used to be able to do on your own.
- How will your investments perform? Over the long run, the stock market has delivered around 10 percent annual returns with dividends reinvested. There are no guarantees in investing, so plan on lower returns. If you estimate you'll receive around 7 percent to 8% percent annual returns for your stocks and 2 percent to 3 percent on your bonds and fund your accounts accordingly, you'll have to save a bit more each month than had you been counting on historic average returns.
You Still Won't Get It Perfect, but That's OK
By building your plans based on these reasonable to slightly conservative assumptions, you still can't guarantee yourself a successful retirement, but you can improve your odds. Just remember, no matter what assumptions you use to build your plans, you should regularly review your progress and make adjustments when needed. If you find yourself off track, the sooner you make corrections to get yourself back on track, the better and cheaper it will be.
Chuck Saletta is a Motley Fool contributor. For more on ensuring a comfortable retirement for you and your family, Motley Fool retirement experts give their free insight on a simple strategy to take advantage of a little-known IRS rule to boost your retirement income.