One million dollars sounds like a hell of a lot of money, but when it comes to retirement, it might not take you as far as you think. The Wall Street Journal refers to this perspective as “the illusion of wealth”. Here’s what it means.
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As they point out, $1 million sounds like a lot more money than, say, $5000 a month. When you ask most people which they’d rather have in retirement — $1 million or $5000 every month — they’d probably go with the million. In the context of retirement savings, though, both amounts are roughly the same, assuming a few parameters. Here’s how the Wall Street Journal puts it:
The first thing to note is that these two amounts are roughly equivalent based on current annuity pricing. (A rule of thumb is that monthly annuity payments are about 1/200th of the corresponding lump sum, assuming they begin at age 65.) And yet, despite this equivalence, people often have sharply different feelings about the two financial descriptions…. Some people feel that $1 million is a much more adequate amount than $5000 a month. These people tend to suffer from the illusion of wealth. Because they get a false sense of security from seemingly large monetary amounts, such as those that appear when they check their accounts, they behave as if the $1 million is more than $5000 in monthly income.
The problem? An illusion of wealth can cause some people to under-save for retirement. It’s, as they say, a false sense of security. Of course, that’s still a lot more than most people have saved.
The point isn’t to make you feel bad if you’re playing catch up. It’s just to point out that 1) saving for retirement is important and 2) it helps to understand the maths. In other words, you have to think beyond the lump sum. When you start to dig into your retirement planning (and the sooner you do, the better), make sure to look at the whole picture: What your monthly expenses will be, how long you expect to make withdrawals, and how much your projected monthly income will be at your current savings rate.