An investment-related topic on Twitter last year stoked outrage. The incredulous tweets were in response to a MarketWatch article that suggested that by age 35, you should have twice your salary saved.
Many Twitter users weren't having it. The reactions ranged from "I didn't have that much saved in my 30s!" to "Well, I'm never retiring, apparently." One of my favorite tweets was this one: "Listen. Meghan Markle wasn't a duchess til age 36 so stop telling me what I should have by age 35."
So what does it take to save twice your salary by age 35, and 10 times your salary by age 67 (full retirement age)? The answer is that it isn't as impossible as you might believe.
Where should you be?
The "save twice your salary by age 35" recommendation comes from Fidelity, which periodically releases these recommended savings benchmarks (See this article in Fidelity Viewpoints). This is the full recommended savings road map, by age, according to Fidelity.
First off, I want to make it clear that these savings "guideposts" are Fidelity's, not Morningstar's. That said, I do think they they are pretty decent benchmarks. I particularly like that they are calculated as multiples of your current salary instead of specific dollar amounts, such as a goal of saving a million dollars by retirement. The problem with homing in on a dollar amount is that it might be a lot more or a lot less than you will need in retirement, depending on your current salary and lifestyle.
The goal in retirement savings and drawdown is to maintain your current lifestyle, plus or minus some expenses--maybe more travel spending but less money required for commuting and new clothing. Many people focus on replacing 80% of their preretirement paycheck. Remember, too, that government pensions will provide some income in retirement. Also--and this is something that people sometimes forget--you still have some earning power in retirement, especially if you maintain a modest allocation to stocks in your portfolio.
How do you get there?
Let's roll up our sleeves and break it down. If you have a financial calculator you can do this along with me, but if not, I'll explain each step as I go. Let's assume we have nothing saved so far (so present value is $0). Our salary is $40,000. The future value is double our salary, or $80,000. The time (or "n" if you're using a financial calculator) is the time we have until age 35 (or the next relevant benchmark). Let's say we're 25, so we have 10 years until 35.
Now that we have those definite inputs, it's time to make educated estimates (we're going to make stuff up). First, let's decide how much stocks are going to return over the next decade. Over the past 90 years, stocks (as benchmarked by the S&P 500) have returned about 10% per year on average. Adjusted for inflation (which is referred to as the "real" return), stocks have gained around 7% per year on average. Does that mean the S&P 500 will earn around 7% after inflation in every year going forward? Of course not--this is just the smoothed-out, average annual return over the past 90 years. Importantly, there is just no accurate way to guess what stocks will do over short-term periods. Over a period as long as a decade, though, 7% per year is as reasonable an estimate as any.
Again, though, there are no guarantees. If you want to be more conservative in your estimate, you can use 6% or 5% as the return for stocks. The result of lowering the growth rate will be that the recommended savings amount rises: In other words, the market won't do as much heavy lifting and you will have to save more. The downside of saving more in the present is that you may have to keep a pretty tight budget, but I'm almost certain you won't regret your asceticism come retirement.
Try this exercise for yourself, using your own information. If you're using a financial calculator, your present value is how much you've saved so far. Your future value is your salary doubled. The interest rate is your market return expectation (in our example, 7%). You can play around with different values: Using a 6% return assumption works out to $252 per paycheck; using a 5% growth rate works out to $265 per paycheck in our example.
The time or "n" is the time until you turn 35 (in our example, 10 years). To solve for the yearly contribution required, hit the "payment" key and then divide the result by 24, or the number of pay periods per year to determine the amount you need to sock away per paycheck.
That might not be how your retirement plan works, though. Many retirement plans require that you elect to contribute a certain percentage of your salary. We can quickly convert this into a percentage: $5,790/$40,000=0.1448, or roughly 15%.
Now for a bit of good news: Part of your contribution might come from your employer in the form of a company match. Let's say your employer matches the first 5% of your retirement contributions at $0.50 on the dollar. That means that if you save at least 5% of your paycheck ($2,000 if your base salary is $40,000), your employer will kick in $1,000. So that means that I only really have to save $4,790 to get into the ballpark I want to be in, which is 12% of a base salary of $40,000.
As long as you target saving ~15% of your salary (including your employer match), you have a good chance of achieving these much-discussed savings benchmarks. The table below shows the dollar amount you would need to contribute to a retirement account per paycheck in order to save 15% of your pretax salary (assuming a 7% return for stocks).
Can you sacrifice $300 per paycheck for retirement security? Hopefully. Though for some it may be out of reach, for others it may be more achievable than previously thought.
Still disagree? Come at me, Twitter. I love a good debate.
This article first appeared in May 2018.
