Objective: learn the percentage of your total income that must be saved throughout your working years for a comfortable retirement. Note: this savings rate is not applicable to someone who didn't save money for a large part of their working years.
In a previous article I described how one should take their savings and invest it for retirement, but I didn't say how much of your income you should save. This important question deserves its own article. This may well be the most important thing you ever read, because most Americans are not saving enough for retirement. A majority of Americans close to retirement age do not have enough savings to provide them with the same living standard as they currently enjoy.(E1)
In my AGEC 1114 class I require my students to use a spreadsheet I constructed to form a retirement plan. This spreadsheet allows them to assume different savings rates (meaning the percent of your total household income you save for retirement) and observe the retirement income it provides. By experimenting with different savings rates, students can identify the rate which affords them a similar lifestyle when they are retired as when they worked.
The vast majority of students conclude a savings rate between 10% to 22% is optimal, and the average is probably around 16%. The Economist magazine (a venerable authority if there is one) argues a rate of 20% is ideal.2 Do some "Googling" and you can find many articles addressing this question, and you tend to find people suggesting at least 10% and preferably more than 15%. A number of retirement calculators can also be easily found. I think the calculator at Vanguard is exceptional. These also suggest a savings rate above 15%.
What is the actual savings rate for most Americans? Around 10-15%.2
I have found that young people are often given a voluntary contribution retirement program by their employer, which means the employer and employee both contribute to investments, but the employee determines how the money is invested and how it will be used in retirement—as opposed to defined pension schemes, where the employer pays for everything and the worker is guaranteed a certain income level in retirement. Their employers tell them they will match 3-5% of their salary, meaning for every dollar they save the employer will add another dollar, up to 3-5% of their salary. The workers then falsely assume that 3-5% is a good savings rate (why else would that rate be chosen?, they think), and those who assume this will come to regret it in retirement. As The Wall Street Journal remarks about poor savers... ,"In general, people facing problems today got too little advice, or bad advice. They didn't realize that a 6% annual contribution, with a 3% company match, might not be enough."1
Quotation 1—Bad advice on saving
In general, people facing problems today got too little advice, or bad advice. They didn't realize that a 6% annual contribution, with a 3% company match, might not be enough
—Browning, E. S. February 19-20, 2011. "Retiring Boomers Find 401(k) Plans Fall Short." The Wall Street Journal.
With so much free information on the internet about money management, there is no excuse for not saving adequately for retirement. The key is to not let the information intimidate you. One does not need to be an expert to plan well, one only needs the willingness to read and think. For your future's sake, that is not too much to ask.
Related Articles
(2) The Risks That Bonds Carry
(3) Saving and Investing for Retirement
References
(E1) The Economist.. April 9, 2011. "Falling Short." Special Report: Pensions.
