Too Much Information – Focus First on Fundamentals

Dedicated to informing readers about matters of personal finance, this special section of the State Journal reflects a trend that offers both promise and peril.

Web-Information.jpgThe good news is that as the baby boom generation approaches retirement, the media and financial services industries are providing more help than ever to the general public about financial matters.

There is, however, a dark side to the rising flood of financial information and advice – namely, that many people do not have enough experience in personal finance to know what matters most.

To illustrate the potential risk of “too much information”, consider the limited effect that lots of good information and advice has had on another important part of our lives – what and how we eat.

Though we have more choices for healthy food in our grocery stores than ever, and more information in the media about nutrition and diet, studies demonstrate that at all income and education levels, our nation has poor eating habits. Clearly, having easy access to good nutritional information does not predict good results – it might even be counter-productive.

For instance, some time ago, I noticed I was gaining weight even though I was taking care to analyze the fat content, fiber, and nutritional components of my food and taking time to educate myself about nutritional matters.

Then someone brought a fundamental fact to my attention – if I consumed more calories than I burned, I would gain weight. Once focused on this simple point, rather than all the tips and techniques I had been reading about, I developed specific tactics (such as not eating as much) for me to maintain the weight I wanted. It was that simple.

In matters of personal finance, as well as food, there is no single path to success. In both domains though, understanding fundamental facts that are common to all people is a great way to start.

So what are some of the “fundamental facts” we should all know about personal finance? I suggest starting with just four – one for each decade of a person’s career up to age sixty.

At the beginning of people’s careers, they need to know at a minimum the following relatively simple math fact:

To have a reasonably high probability of having enough money in retirement to sustain a standard of living that has grown modestly over a career, an early “twenty-something” ought to save at least 20-25% of their ongoing cost of living per year. If a person waits to start saving until age 30, they should save 30-35%.

Having absorbed this sobering mathematical fact about saving, by the time people get to their thirties they need to know a similarly fundamental fact about investing:

Over most long periods, diversified stock funds provides better returns for the risk taken than investing in individual stocks; similarly, investing in multiple categories (small/mid/large, value/growth, domestic/international) of stock funds tends to produce better results than in just one category of stock funds    .

(In a recent AARP study, less than half of those questioned knew this fact.)

When people reach their forties, they should start thinking about “the number” – that is, how much they need to accumulate in savings to retire comfortably. The first fact to learn is how much someone is spending in their forties, though this varies from family to family. However, the next essential fact to know applies to everyone:

Sophisticated research has concluded that to have a high (90%) likelihood of maintaining a given standard of living over the course of a 30-year retirement, retirees should have roughly $1 million in a diversified portfolio for every $40,000 they plan to withdraw in the first year of retirement.

In other words, a person who wants a high probability of maintaining a $120,000 inflation-adjusted distribution from their retirement savings needs to have $3 million invested when they reach retirement.

Around the time people reach their fifties, they can apply the research cited above to estimate the specific likelihood that they will be able to maintain their standard of living without earned income, given existing spending practices. To assess how long they should plan to fund their retirement, they should know the following fact:

Actuaries have determined that for a couple in their early sixties, there is a roughly 50% chance that at least one partner will live past age 90.

Of course, fundamental facts like those listed above are not all that people need to know to take good care of their financial future.

However, they do provide a solid foundation for applying the more specific financial planning tips and techniques swirling around the marketplace. Indeed, without such a foundation, such tips and techniques can create a false sense of security that can cause more problems than it creates.