Not too long ago, in a Galaxy a lot like this one, financial planners such as myself advised clients based on a “three-legged stool” of retirement that included Social Security, a pension, and savings. In all three buckets, people had money they could depend on, making for a comfortable and secure retirement. Not only that, they had a solid back-up plan in the event they ever fell short — their home equity.
For decades, the ability to cash in your home equity if you were on track to outlive your money was many retirees’ saving grace. A reverse mortgage or the sale of a home have arguably been two of the most dependable retirement short-fall plans. But these days, Millennials are delaying buying homes, or scrapping plans for doing so altogether.
A recent survey from ApartmentList.com found that 12.3% of Millennials expect they'll "always rent," up from 10.7% in 2018, and the rate of homeownership for Millennials is 8% lower than it was for Gen-Xers and Boomers when they were in the same age group.
Couple that with the fact that pensions are almost nonexistent, the future of Social Security seems questionable, and Millennials are further behind on their savings than any other generation, and I’m beginning to worry that Millennials and the Gen Z’ers following shortly behind them will be attempting to sit atop a stool with no legs at all.
Of course I’m not blaming them by any means — their lives have been put on hold due to crippling student loan debt, which has forced them to pour money into past experiences rather than save for the future. But that doesn’t change the fact that the most recent stats are pretty bleak — today, 52% of all American workers say they're behind in retirement, according to a new study from Bankrate.com. Just 16% feel they’re on track. Additionally, 38% of U.S. workers say they’ve never had a retirement account, and 49% of those with accounts have withdrawn money before retirement age, paying an untold amount in taxes and penalties over the years.
Real Talk About Today’s Retirement
Today, many of the financial industry’s foremost experts including Mary Beth Franklin at Investment News and Wade Pfau with the American College of Financial Services are now encouraging people who lack retirement savings to consider home equity as a fall-back plan. The Federal Government has also stepped up, and introduced a Federally-backed reverse mortgage.
This is great, but the truth is that not everyone (particularly those in large and expensive cities) will be able to save the required down payment for a home, and many Millennials who are happily living as digital nomads simply don’t want the responsibility of home ownership. That’s fair… but increasingly I find myself advising my younger clients that even if they don’t want to own a home, they have to find another way of creating a safety net equivalent to what homeowners are accruing as home equity. In other words, you can rent for the rest of your life if you want, but you should still save as if you were a mortgage-paying homeowner. Allow me to explain.
Home Equity (Or Its Equivalent) To The Rescue
If we consider mortgage underwriting guidelines as a rule that determines how much home we’re qualified to purchase, why not use those same guidelines as a barometer for how much we should be saving, and put money aside as if we have a mortgage payment to make every month?
I’ve noticed that many of my Millennial clients — while they may diligently stick to a budget — tend to spend every dime they have “left over” at the end of the month. For example, they’ll put money in their 401(k), they’ll pay for their groceries, rent and healthcare, and they’ll even have a good-sized emergency fund, but then they’ll spend absolutely everything else that isn’t allocated. Certainly, I did my fair share of spending on the “fun” stuff when I was younger, and every budget should include wiggle room for nights out with friends… but when you aren’t building home equity, you still have to save as if you were.
Here’s how I recommend thinking about it: In the mortgage industry, something called the “back-end ratio” is used to determine whether or not someone can qualify to purchase a new home. This ratio is calculated by adding together all of a borrower's monthly debt payments and dividing that number by their monthly income. The goal is that your debt should not exceed 45% or your annual income. So if you earn $100,000 per year, your total debt payments should be no more than 45,000 or $3,750 a month. Simple enough.
My argument is that even perpetual renters should keep this 45% figure in mind — so you shouldn’t be spending 20% on rent every month, and then blowing the other 25% on food and travel. You should try to save the full 45%. In other words, sock away what would be your “home equity” into savings, so that you’re prepared to weather a potential retirement income shortfall decades down the line.
So, What Does this Mean?
As a financial planner who’s now mapped out myriad retirements with multiple generations, it worries me to see a new generation of investors who live for today and don’t worry about tomorrow. That’s why I’ve begun advising all my clients to behave — or at least save — more like homeowners. No, my conversations with my clients around long-term planning may not fit the industry model, but I’m a big believer in facing reality before it’s too late. Because if there’s one thing I’ve never heard a single client say it’s “I shouldn’t have saved so much.”
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