Saving 10% of your income is NOT ENOUGH! Here's why

When people talk about saving for retirement the common assumption is that you should be saving 10 to 15% of your income. But how do you really know if this is the right number? How can you be sure that you will not fall short? When you're young and have all your life ahead you have plenty of time to make changes and adjustments when it comes to your retirement funds. But the more you get closer to the age of retirement the room you have for mistakes keeps getting more and more narrow. And falling short can have a detrimental effect on your lifestyle. 

Throughout your life as your income level increases so is your standard of living which means you earn more money but your monthly expenses are also higher. 

and that’s why most financial advisors would suggest building your retirement fund by allocating a certain percentage of your pretax income. Now unless you are extremely diligent with saving for your retirement and you do that in addition to saving for other things like buying a house or your annual vacation and you start when you are in your early 20s there is a good chance that 10% will just not cut it. 

For most people, the goal in retirement is to keep the same level of living before and after retirement. The problem is that it is not always possible to stay consistent with saving 10% throughout your entire life. When you break it down to the different life stages some will be easier than save in than others. Let see how this works. Most people will be finishing up high school and start working or go to college or university. You will be single or have a spouse for a while before you will have kids. Potentially as a student you will be still living with your parents or with roommates and your income will be low but so as your expenses and liabilities. This will be a great opportunity to start saving money aggressively for a down payment on a house as well as for your retirement. 

In the next life cycle, you will be starting a family buying your first or upgrade your home and you will potentially have your family to support you. 

In this stage, your income will probably be higher however one parent could potentially be taking some time away from work and your mortgage and child expenses will be high. At this point, it will be really difficult to save for retirement as you are mostly focusing on not going into debt while you are also trying to save money for your children’s education.

In the next life cycle, your career and income should be at the peak, your kids are most likely moved out and your mortgage is paid off completely or very close to it. This would be a great phase to really push on those retirement savings If you start saving for retirement at an early age this would really take the pressure down because your portfolio had 30 or 40 years to grow before retirement and another 20 or 30 years after you retire.

Now, Let’s look at a few scenarios and see how the duration of you saving for retirement can affect the percentage of how much you need to save in order to accumulate the same portfolio size. 

First Example

Let’s take Micheal, a web developer who is a completely made-up guy who earns 55K a year and starts saving 10% of his pre-tax income when he is 25. If his retirement savings portfolio earns 5% annually before inflation or a 3% real return after 40 years he would accumulate 409 thousand dollars in his retirement fund

Second Example

The second person we will look at is Dana which works full time as a nurse and follows a more typical and common life cycle case scenario. Dana earns the same amount of income but saves 20% of her income in the first 10 years between the age of 25 and 35. Then for the next 20 years 35 and 55, she saves $0 because of her high expenses. In order for her to accumulate the same amount in her portfolio when she reaches 65, she would need to save 17% of her income for the next 10 years between the age of 55 and 65. 

Third Example

The third person we will look at is Robert. Robert is a construction worker who was not able to save anything between the age of 25 and 35 because he was too busy living the good life. Then when he married Becky and had his 3 kids, Due to high mortgage payments and high kids related expenses he was not able to save also between the age of 35 and 55. For Robert to accumulate the same amount as Dana and Micheal when they all reach 65 he would need to save between the age of 55 and 65 a whopping 65% of his income. This means he would have to save 6 and half times more than what you would have if he started saving at the age of 25 like Michael. No pressure.

You got the point. It is extremely important to start saving for retirement when you are young if you want to lower the pressure the more you get closer to your retirement age. It is worth mentioning that these 3 scenarios reflect the fact that their income was only increased to keep up with the inflation rate which is pretty conservative. But as we discussed earlier usually when your income level goes up so does your expenses. Now do keep in mind that you would always have the option of working past the age of 65 which reduces the total amount of assets you would need in order to keep the same lifestyle level even after you retire due to a shorter retirement. But no one really would volunteer to do that so it is always recommended to have this as a fallback plan if thighs go wrong with your retirement planning

Now here is how you can look at it in a simplified way. To accumulate the same amount of assets when you retire if you start saving up when you are 25 would be 10%. If you wait 5 more years you would need to save 12% and if you wait until you are 40 you would need to save 21% of your annual pretax income to hit the same retirement goals. So as you can see determining what is the right percentage to save for retirement really depends on your personal circumstances like how old you are, how much your income is, how old are you planning to be when you retire and what kind of a lifestyle are you planning to have throughout your retirement years. 

Really the best way to know how much you need to save it to run a financial projection of your retirement and then work your way backwards. this way you would know if you need to save 10, 15, 20% or even more than that. 

For more personal finance and investments blogs, videos and free online courses visit my website