It’s hard for young investors to really visualize how much they should be saving in order to meet their needs for retirement. But with some recent studies from Vanguard and Fidelity investors now have a few guidelines to make sure that they stay on track with saving for retirement.
The first study comes from Fidelity . It includes a lot of assumptions and estimates (more on that later), but if you have no idea on how much you should be saving for retirement, this will give you a rough idea on where you need to be along the way.
First, you need to guess how much annual income you will need at retirement. You want income to cover living expense, medical bills, a car payment, maybe rent or a house payment, etc. With that number in mind here are some guidelines to be sure you will be able to have that income at time of retirement.
- At age 35 you should have 1X that desired annual income saved up.
- At age 45 you should have 3X that desired annual income saved up.
- At age 55 you should have 5X that desired annual income saved up.
- And at retirement (here they assume age 67) you should have 8X that desired annual income saved up.
So lets say you estimate you will need $50,000 a year in retirement to fund expenses, travel, car payment etc.
- At age 35 you should have $50,000 saved up in retirement accounts
- At age 45 you should have $150,000 saved up in retirement accounts
- At age 55 you should have $250,000 saved up in retirement accounts
- And at retirement you should have $400,000 in retirement accounts.
What does Fidelity assume in this study?
The “8X savings guideline” is based on a hypothetical worker saving in a workplace retirement plan, such as a 401(k), beginning at age 25, working and saving continuously until 67, and living until 92.
Fidelity also assumes:
• The employee will make continuous annual salary contributions to a workplace plan beginning at 6 percent and escalating 1 percent per year until 12 percent, plus receive an ongoing 3 percent annual employer contribution during their career.
• The calculation assumes a lifetime hypothetical average annual portfolio growth rate of 5.5 percent.
• Social Security payments are factored in.
• The employee’s income grows by 1.5 percent per year over general inflation with no breaks in employment or savings.
Personally, I think these numbers are a bit too conservative and I would aim a little higher to say, 10X to be safe. But I am not your financial advisor so be sure you talk with a professional about your retirement plan before acting.
But this gives some great basic guidelines for new investors who may be unsure about how much they need to save.
So how do you get to that “8X” level? Vanguard has a study recently that details; 1) How important getting started early really is and, 2) Affects of asset allocation on your retirement goals.
First lets look at what Vanguard projects a simple 50% stock / 50% bond asset allocation will return for investors who save 6% of their annual salary until retirement.
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This assumes a salary of $30,000 at age 25, $51,372 at age 35 and $64,090 at age 45.
Notice that a 6% savings rate starting at age 25 doesn’t quite get us to our goal of $400,000 saved up at retirement (If we are aiming for a $50,000 annual income at retirement). Therefore, I think it is safe to assume that a 25 year old investor today should be either saving more than 6% or hold a slightly higher allocation in stocks.
Shown below are examples of a 25 year old investor’s estimated returns with a higher savings rate (9% instead of 6%) or a higher asset allocation in stocks (80% instead of 50%).
Here both of these scenarios get us to Fidelity’s magic “8X savings” goal.
So as a very rough guideline, a 25 year old today should be savings about 9% of their annual income with a 50/50 asset allocation, or bump up their asset allocation to roughly 80% stocks with a 6% savings rate.
Now obviously if you can save more do so, because Fidelity’s assumptions are fairly conservative. More than likely, you will be out of employment once and won’t get those consistent raises throughout your whole career.
What if you are getting started late? How does that affect how much should you be saving?
Getting started only 10 years later, at age 35 means that even with a 9% savings rate, you will not reach the magic “8X” number.
If you are getting started saving for retirement at age 35, you need to be saving much more than 9% with an asset allocation slightly heavier in stocks if you want to meet Fidelity’s basic guidelines (According to Vanguard’s simulations).
If you are getting started saving for retirement at age 45, you need to be saving much more than 15% of your annual salary with an asset allocation heavier in stocks if you want to meet Fidelity’s basic guidelines (According to Vanguard’s simulations).
An important clarification is needed here. An asset allocation higher in stocks has historically returned greater than an asset allocation higher in bonds but there is no guarantee that happens in the future. A portfolio with a higher allocation to stocks has also historically endured much more volatility. This means that if you use an asset allocation higher in stocks (such as 80/20) you are more likely to have significant drops in the value of your investments. If one of those drops occurs close to retirement, you may not be able to retire on time.
A high asset allocation into stocks is not an excuse to save less.
These numbers are far from certain. Final totals are based on assumptions from historical stock market returns that may not prove to be true in the future.
However, for a beginning investor with no idea about how much they should be saving, these studies will point you in the right direction.
Clearly, getting started early is the most important factor in saving for retirement. Not saving a little now means having to save a lot later. So use our resources here at Begin To Invest to get started today!