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msnbc.com contributor
updated 11/15/2007 4:10:05 PM ET 2007-11-15T21:10:05

Yikes! You woke up this morning and suddenly realized you haven’t saved a dime for retirement — and you’re already middle-aged!

What now?

In a perfect world, every 40- or 50-something would have a tidy nest egg. But in real life, other financial priorities often come first — putting your kids through college, medical expenses, just living day to day...

But now it’s time to buckle down. After all, fewer and fewer Americans can rely on the traditional pensions that kept their parents comfortable in retirement, and the government may have a hard time providing the full Social Security benefit it has promised.

So savings and investments are essential. And if you assume you’ll live to 95 or 100, it will take a lot.

Consider this frightening fact: To produce $1,000 in monthly retirement income, it will take a $300,000 nest egg.

That’s because a widely used rule of thumb says retirees should spend no more than 4 percent of their nest egg each year. That $1,000 a month is $12,000 a year — 4 percent of $300,000.

If a 4 percent “withdrawal rate” seems low, it’s because the withdrawals need to grow every year to counteract inflation, which can double prices in 20 years. For withdrawals to grow, the nest egg has to grow.

In other words, every $100 in savings might earn $7 a year with a good mix of stocks and bonds. You could spend $4 and leave $3 in savings, so you’d have $103. Then the next year you’d earn $7.21, and you could spend $4.12 — 4 percent of $103. Your spending would go up by 3 percent to offset inflation.

As the years go by, you’d probably need to dip into the principal rather than just live off investment income. So the 4-percent-a-year rule assumes you’d probably spend all your money by the time you’re 95 or 100.

If you’re already 50 or so, it will take some belt-tightening to accumulate $300,000 by the time you’re 65. You’d have to save about $16,000 a year and invest it at a 7 percent annual return. (The actual number would vary depending on your tax situation and other factors.) Obviously, if you need $2,000, $3,000 or $4,000 a month to fill the gap between your expenses and other income, such as Social Security and pension, your belt needs to be even tighter.

Okay, so much for the scare tactic. Maybe the situation isn’t as hopeless as it looks. Here are some suggestions for getting going.

Start by looking at your spending. Keep a record of every penny that goes out over the next couple of months. And I mean every penny — every bag of potato chips or quarter put into a parking meter.

Then look for things to trim. Start with cuts that are easy and won’t hurt, like bottled water when tap water will do. Work your way up to things like entertainment, meals out, premium cable service or unlimited long-distance calling plans. Many households can trim hundreds of dollars of monthly expenses with no serious effect on quality of life.

Still, you might have to take more extreme steps, like getting rid of the second car, moving to a cheaper place or vacationing at a campground instead of a resort.

Remember that a dollar saved today is worth a lot more than a dollar saved in five or 10 years, because it will have more time to compound as an investment — to grow as you earn interest on interest.

Now think about your life in retirement.

Retirement calculatorAnother rule of thumb says it will take 70 to 80 percent of your pre-retirement income to maintain your standard of living in retirement. But you might be comfortable on less. Maybe your mortgage will be paid off by then, or your children will be grown. Perhaps you’ll want to move to a smaller, less expensive place, converting some of the equity in your current home to cash for living expenses.

If you do have a pension at work, ask your benefits folks how much you’ll receive and how the figure will change depending on how long you stay on the job and how much your income grows.

Also, look carefully at the Social Security statement that comes each year a few months before your birthday. It estimates your retirement benefit, assuming you keep earning as much as you do now. (You can get an estimate right away at the Social Security Administration's Web site.)

Think about postponing retirement a few years, or continuing to work part-time after you "retire." This will give your investments longer to grow and reduce the number of retirement years you need to fund.

The effect can be dramatic. By planning to retire at 70 instead of 65, the 50-year-old in the example above would have to save just $11,000 a year instead of $16,000. And if you assume this person will get raises and be able to increase annual savings by 3 percent every year, the figure drops to about $8,400 – only about half of what we started with.

To produce these kinds of figures for yourself, get some good financial software for your computer. The most common, Quicken, has a good, easy-to-use retirement planner that will tell whether you’re saving enough. It shows how changing variables such as the projected investment return, the inflation rate or retirement age can affect the results.

Of course, smart investing is critical — and you don’t have to be a financial genius or turn investing into a second job.

Don’t be afraid of stocks. Historically, they have returned 10 or 11 percent a year, about twice the return of bonds and three times that of bank savings or similar “cash” investments, which don’t grow at all once inflation is taken into account. Yes, stocks are volatile, meaning there are years when the average investor loses money. But the big years more than make up for that.

The key is to be able to keep your money invested for at least five or 10 years to ride out the downturns. Even if you’re already 50 or 55, that’s not a problem, since some of your stock holdings won’t be needed for for 10, 15, 20, even 30 years.

Use the “asset allocation” tool on Quicken to figure the best way to divide your money between investment classes. It might, for example suggest 60 percent in stocks, 30 percent in bonds and 10 percent as a rainy day cash fund. Most brokerages and mutual fund companies have similar calculators on their Web sites.

Don’t worry if you have no experience picking stocks and bonds. Use mutual funds, which employ professional managers to do that work. To simplify that search, look at index-style funds which match the performance of the broad market. Indexers charge very low fees, which can make a big difference in the long run. Aim for those charging less than 0.20 percent a year.

Some of the big fund companies such as Vanguard Group and Fidelity Investments offer a wide range of low-fee indexers, and they can help you select suitable ones. Take a look, for example, at Vanguard’s Total Stock Market Index Fund, which tracks the U.S. stock market, and the firm’s Total International Stock Index Fund composed of European, Asian and emerging-market stocks. At Fidelity, look at the Spartan Total Market Index Fund, a U.S.-stock fund, and the Spartan International Index Fund, which tracks foreign stocks.

To find similar funds from other companies, use the site of fund-data firm Morningstar Inc.  Enter the funds' ticker symbols into Morningstar’s Similar Funds tool to find other funds with the same investment strategies. Also use this site to search for indexers investing in bonds.

Finally, think about getting professional help, preferably the "fee-only" advisors who charge an hourly rate or flat sum to prepare a comprehensive financial plan you can implement yourself. They don’t have the conflict of interest that can be a problem with brokers or other advisors who earn sales commissions or need to promote their own firm’s products.

The National Association of Personal Financial Advisors, the trade group for fee-only advisors, has a referral service on its Web site. Steer clear of anyone who wants to take over your portfolio and charge an annual fee based on your holdings. Paying 1, 2 or 3 percent a year can be terribly damaging in the long run. And you don’t need a lot of day-to-day management — you just want to put new money into a set of index funds every month and leave it alone.

The fee-only approach costs more up front — perhaps several thousand dollars. But it will be worth it if it helps you avoid big mistakes and expenses over the long run. A plan touch-up every year or two should be much cheaper.

The important thing is to get started right away. Time is the investor’s best friend, allowing you to wait out the stock market’s downturns and get the most from the snowballing effect of compounding investment returns.

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