Are you saving enough?

It might seem like the most basic of investing questions, but for many people, the “right” answer is elusive. Even people who are comfortable tackling sophisticated financial tasks like determining their asset allocations and conducting due diligence on individual stocks and funds may hem and haw when it comes to assessing the viability of their savings rates and, in turn, the soundness of their plans.

It is not hard to see why. The right level of savings depends on a huge gamut of factors, many of them highly dependent on each individual and others simply unknowable. Unless retirement is close at hand, few of us know how much we will want or need to spend in retirement; nor do we know how much of a helping hand market returns will provide over our holding periods, both in the years leading up to retirement and during it. And then there is the mother of unknowables: the duration of our retirement years, which requires us to forecast our own life expectancy.

While there is no way to answer most of these questions with any degree of precision, there are tools and other strategies you can use to assess whether your current savings—combined with the amounts that you will save on an ongoing basis—put you in the right ballpark. Using those tools as a baseline, you can then tweak the specifics of your plan based on your own variables.

Rules of Thumb Are Just That
Of course, there is no shortage of rules of thumb available to gauge savings rates and, by extension, the soundness of an investment plan. Investors may have heard that they should be saving 10%, 15%, or 20% of their salaries.

But those rules of thumb can be dramatically affected by the assumptions underlying them. For example, a study from the Center for Retirement Research at Boston College suggests that individuals earning an average wage who save 15% of their annual earnings from age 35 to 65 will be able to retire at age 65 with financial security, assuming a 4% real return on investments. But if they are able to delay retirement (and portfolio withdrawals) until age 70, their anticipated savings rate drops to just 6%, according to the study.

In attempting to help investors address the “how much is enough?” question, experts suggest that investors could reasonably target a retirement nest egg amounting to eight times their ending salaries. By age 35, investors should aim to have set aside a retirement kitty equal to their current salaries, with retirement assets escalating to three times current salary by age 45 and five times salary by 55.

Those guideposts are useful starting points, but research also demonstrates how sensitive retirement preparedness and savings rates are to individual-specific factors. While research suggests that a savings target of eight times ending salary is a good baseline, it makes assumptions about income-replacement rates and the length of retirement, among other factors, to arrive at that figure.

For example, an individual who is expecting to replace just 80% of the salary she had during her working years—rather than the 85% income-replacement rate assumed in the study—will need to save less than eight times her ending salary, all other factors being held equal. Meanwhile, an investor who wants to retire at age 62—rather than the age 67 retirement date that underpins the eight-times-ending-salary savings target—will need to come into retirement with more than 11 times ending salary.

Calculators Enable Customization
Because savings targets will be so sensitive to individual-specific inputs, personalized planning sessions or online calculators that allow investors to adjust these inputs are the best way for investors to determine the adequacy of their savings rates.

Because various tools can provide different results—and because retirement readiness is such an important issue—be prepared to sample a range of calculators and outcomes rather than settling on just one. Also, focus on the most holistic tools you can find; as some tools incorporate Social Security income and also takes into account the asset allocations and tax treatment of various asset pools in the investor’s portfolio.

As you work with these calculators, it is also valuable to tinker with the inputs—rather than relying on any preset inputs—so that the calculator is factoring in your own situation. If it looks like you will fall short based on your starting assumptions, you can make adjustments to help improve your probability of success.

The Swing Factors
Among the variables you will be able to customize—and that have a big effect on the success or failure of a retirement plan—are the following.

  • Income-Replacement Rate: Generally speaking, higher-income workers and heavy savers will need to replace a lower percentage of their working incomes when they eventually retire than will lower-income workers with lower savings rates.
  • Anticipated Retirement Age: Being willing to work longer can deliver a benevolent three-fer; the person who delays retirement can continue to accumulate savings, while also increasing Social Security benefits and decreasing portfolio withdrawals. All three steps can have a powerful effect on a portfolio’s staying power.
  • Life Expectancy: Predicting your own life expectancy is the trickiest business of all.
  • Expected Rate of Return: Be conservative here, especially if your portfolio is bond heavy, and customize your expected return based on your asset mix. To calculate your portfolio’s expected return based on its asset allocation, simply adjust your anticipated return for an asset class based on its weighting in your portfolio. For example, if you have a 60% equity/40% bond portfolio and you expect 6% (nominally) from stocks and 2% from bonds, your portfolio’s expected return is 4.4%. (The 6% equity return times its 0.6 weighting (3.6%) and the 2% bond return times its 0.4 weighting (0.8%).)
  • Savings Rate: This will be a bigger swing factor if you are earlier in your savings career and have more time to benefit from compounding. A study from the Center for Retirement Research demonstrates that older individuals looking to make up for a savings shortfall will need to ratchet up their savings significantly to get their plans on track; they will improve the viability of their plans more if they are willing to delay retirement and/or reduce their planned in-retirement spending per year.


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