Retirement Heuristics

Heuristics or rules of thumb, although not cast in bronze, are used much of the time to allow us to make a quick calculation.

Here is one example. Don’t try to bribe a Toronto police officer. You would be silly not to bribe a Mexico City police officer.

For another example, take the rule of 72. That rule states that the length of time required for an investment to double in value is equal to 72 divided by the annual percentage interest or earnings or dividends generated by the investment.  For example, if an investment earns 10% annually, it will need 7.2 years to double in value (72/10). If it earns 6% annually it will need 12 years to double in value (72/6), and so on.

We can use the rule of 72 to estimate the impact of inflation. The average rate of inflation over the years has been 3.22%. That means all other factors being equal, in 22 years (72/3.22) things will cost twice as much as they do today. 22 years in retirement is common. A person earning $52,000 a year and entering retirement today will need an income source that generates $104,000 a year to maintain the same living standard 22 years from now.

Without articulating it, we use rules of thumb regularly to help us get through the day.

There are retirement rules of thumb, of course. A good one is we should not tell our children how to bring up their children.  Then there are retirement heuristics.