Why Saving Only For Retirement Can Backfire

Maxing out your 401(k) contribution is usually the golden rule of retirement planning. But what about all the other things you want to do before you retire that can’t be funded by a 401(k), such as sending your kids to college, or paying for their weddings, or even something as frivolous-sounding as buying a boat? Are we supposed to defer those dreams lest we wind up destitute in our old age?

A new paper by David Blanchett, head of retirement research at Morningstar, suggests that focusing too much on retirement at the expense of everything else is actually an inefficient way to plan. In contrast, clearly defining all your financial goals and then prioritizing saving for them over your lifetime—as opposed to saving just for retirement, or attempting to fund all goals at once—will lead to the best results.

The power of having a financial plan in the first place has been copiously documented. But taking a goals-based approach goes one step further by having a bunch of plans for each desired outcome, instead of one big pool of savings. This could mean creating a portfolio of sub-portfolios, with each account earmarked with a particular threshold for a particular goal. Psychologically speaking, this changes the stakes so that the risk is no longer not beating a particular benchmark in the abstract, but failing to reach the goal. (I literally name savings accounts after the thing I’m saving for—it’s motivating to see your desires articulated on a monthly statement.)

Blanchett even recommends breaking retirement itself down into several goals so that you can establish their relative importance: meeting your most basic needs with about 50% replacement income (the rest funded by social security), meeting your needs with some extra discretionary spending, or even going beyond replacing your current income if, for example, you envision tons of traveling. (Blanchett calls these three retirement tiers “needs, wants and wishes.”)

This allows you to take a slight step back and see, for example, that it might be more important to pay off debt in your 20s than contribute the max to your 401 (k), or start a house fund in your 30s, and 529s in your 40s, etc. When Blanchett ran a hypothetical couple through a wide variety of different scenarios, this goals-based approach to saving and funding came out on top. “What’s important is to take a holistic approach,” says Blanchett. “Let’s not not fund other goals that could be more important at that time than retirement.”

Granted, your goals may change over time—that’s okay. No one expects you to start a 529 before you’ve even had children. The one constant is still to save for retirement, but just to varying degrees over your lifetime. (For one strategy, see How to Balance Saving For Retirement with Saving for Your Kids’ College Education.)

All this planning is part of what Blanchett calls the gamma, the extra value that can be added through intelligent financial decision-making above and beyond the investments themselves (with beta as the average market returns and alpha the excess returns from actively managing investments). As Blanchett says, “The investments themselves are an important part of the journey, but it’s only a part of the journey.” First you have to have not just one but many plans for where you want to go.

Konigsberg is the author of The Truth About Grief, a contributor to the anthology Money Changes Everything, and a director at Arden Asset Management. The views expressed are solely her own.