Most people know they need to save for retirement, but they don’t know what their “magic number” is. They may not know how much to save on an annual basis nor the duration of those savings.
This is all very understandable, I suppose. Retirement expenses may vary depending on where you will be living and what kind of lifestyle you will be living. It’s very hard to predict what your life will look like in 30 years, let alone 5 or 10!
According to a survey from the National Association of Personal Financial Advisors (NAPFA), one in three Baby Boomers—Americans who are nearing or starting retirement—hasn’t done any financial planning in the last two years. How do they know if they are on track? This is worrisome to me.
While there is no one-size-fits-all approach, there are some rules of thumb that people can use to obtain more clarity with their financial situation:
Pick a goal and work towards it. Some investors work best by targeting a specific retirement savings goal ($1mil? $2mil? $10mil?) and back-in to a savings goal from there. Using simple numbers, if you are starting with $0 and want to get to $1,000,000 in 20 years you can use any savings calculator (here’s one) and it will tell you what amount you need to save. Assuming a 6% rate of return with the numbers above, you would need to save $2,164 a month (approx. $26k a year) to get there.
This may be used as a general framework using arbitrary numbers, because who knows if $1mil for you is enough? If you wanted to know a ballpark savings amount to target, this is a decent start. You can play with these numbers and assumptions and see where that gets you.
The 25x Rule. This rule says you need to save 25 times your annual expenses (not your salary) to retire. And once you have gotten there, you may be considered “financially free”. For example, if you anticipate needing $50k from your investments in retirement, you’ll need a nest egg of $1,250,000.
Some people in the industry like this guideline because it’s very simple to compute. No complicated formulas needed. The downside would be the age of when you reach this (55? 85?) and which accounts you have (IRA versus non-IRA). The social security situation and the tax environment may also muddy the scenario. All in all, the simplicity – and the math behind it – works for many people.
Make a budgeting rule. This is a common method in which a household decides to allocate percentages of their income towards various buckets. The common “50-30-20 rule”, illustrated below, is one where 50% of income goes towards an essentials bucket, 30% towards personal/lifestyle, and 20% towards savings/debt.
Essentially families would be spending half their money on “needs” like housing, utilities, and food. One third is spent on things like gym memberships, dining out, and vacations. The smallest part at 20% would be used to eliminate debt and save for retirement.
Many families I work with, including my own, like using this arrangement. They find it helps them make more disciplined decisions on a daily basis. On the flip side, there are certain people who don’t enjoy structure nor micromanaging their spending. People like my wife just want to know “how much can I spend?”, and that’s OK too!
Age-Based Goals. I use these guideposts often, to give people a benchmark of where they are. I have seen a few different versions of this, but here’s one from Fidelity:
The calculation is straightforward. For example, a 50-year-old making a $150,000 income should have $600,000 saved for retirement. Not there yet? There is still come to catch up…but note that the warning bells have rung!
Save a certain percentage, regardless of age. I’d say the absolute minimum savings rate should be 10% of income, ideally 20% or more. Some experts say 15% is a good number. Obviously the lower the savings percentage, the longer you potentially have to work.
Along the same lines, put time on your side and start saving early in life. Studies show that if you start saving at age 25 versus 35, you would end up saving half as much and in half the amount of time, and still have more in retirement!
My recommendation is setting up automatic savings from a paycheck or bank account. That way you don’t have to think about it. If you’re automatically putting away 15% of your salary, a company match or unexpected bonus could very well get you to 20%+ by year-end.
Think that’s unattainable? I’m not going to say it’s easy. But hey – I read about people who save 50% and share their stories about how they managed to do it. It’s all very possible, and people are doing it.
These rules of thumb may be helpful, but keep in mind there are no guarantees with anything. In fact there are several complicating factors that aren’t being discussed here. For example, we didn’t talk about what “retirement” means, because it’s different for everyone (and that’s a whole different topic). For some, it means retiring by 45!
Some of the other moving pieces in this financial planning puzzle could be the status of social security, pensions, or other potential sources of income. Similarly, I would not recommend planning on an inheritance, even though one may eventually come. Don’t forget about inflation. And of course, you have to be prepared for the unexpected – unanticipated medical situations can wreak havoc on your plans.
I’m not here to beat anyone over the head if they aren’t saving enough, to each their own! Everyone’s situation is different. But I think these rules of thumb can be helpful.
If nothing else, I hope this helps put things in perspective. Apply some of these yardsticks to your situation and see how you are stacking up. Share them with a parent, a sibling, your kids, or a good friend. And if you or someone you care about is worried they are falling behind, have them reach out to a professional for assistance.
Fine print: as usual, performance is never guaranteed and these figures are just used for illustration purposes!