The following is a guest post from Marotta Wealth Management.
I often get comments like "It's too late for me to do this" or something similar. Granted, it's usually better to start financial efforts (saving, investing, growing your career, etc.) sooner rather than later so compounding can work for you. But it's better to start now rather than put it off any longer. And while you'll need to make sacrifices if you start late, it's not hopeless.
Knowing how much you should save for retirement is critical. But what if you are late getting started? The longer you delay, the shorter the time that compound interest can do its magic on your savings.
We typically recommend that you save 15% of your take-home pay each year. Money in the bank isn't compounding. Invest the money in an age-appropriate portfolio and rebalance regularly. Make sure your investments choices have low fees and expenses. Assuming you start at age 25, you should have sufficient assets to retire at age 65 after 40 years. Short-term market volatility should not deter long-term investing.
Retirement planning is like the pioneers who set forth on the Oregon Trail. The hardy souls who began their journey in early spring had to average 15 miles a day to reach their goal. But those who delayed until summer needed to maintain a faster pace. The same is true of saving for retirement.
Beginning at age 25 and retiring at 65, the appropriate savings rate is 15.4%. But starting just five years earlier, you could reach the same goal by saving just 11.1% each year. Starting early is more important than saving more.
If you start at age 20, you will have saved nearly an entire year's salary by the time the couple delaying is putting in their first 15%. In fact, the family starting earlier will be ahead of the family starting later all the way up until age 65. This is true even though they will be saving 5.3% less of their salary each year.
Deferred consumption is the definition of capital. When a family defers consuming and saves and invests instead, they put that capital to work. Having more money invested early means their investments are making money and adding to their savings, which reduces the amount they need to add. Money makes money.
Starting at age 15 is even better. For students who work summers and start saving, the safe lifetime savings rate is only 8.04%. Starting early is so beneficial that you can lower the rate you need to save each year. Thus every sage investor suggests beginning as young as possible.
Late April or early May was the best time of year to set begin the arduous trek to the West. If you waited too long, you would have to push farther each day or risk getting trapped in the mountains by an early snowstorm.
The same is true of retirement planning. The later you start in life, the higher the percentage of your lifestyle you must save. Starting at age 25 you should save 15.4% of your lifestyle each year to reach financial independence by age 65. For every year you delay, add about 1% in your 20s and 2% in your 30s.
Here's one of my favorite math problems: If a wagon train averages 10 miles a day for the first half of the Oregon Trail, how fast does it have to travel the second half to average 20 miles a day for the entire journey?
Most people wrongly answer 30 miles a day. But if the trail is 2,000 miles long, to average 20 miles a day you would have to travel the entire trail in 100 days. But if you averaged 10 miles a day traveling the first 1,000 miles, you would have already used up 100 days. You would then have to travel the second thousand miles instantly to overcome your slow start.
Starting at age 30, we suggest you save 21.4% each year. By age 35 it rises to 30.1%. And at age 40 it is 43.2%. Saving half your salary is difficult at any age. Lowering your standard of living to begin saving at age 40 is even more challenging.
By age 45 the percentage rises to 64.2%, and at age 50, you must save 100% of your lifestyle to reach retirement at age 65.
Saving 100% of your lifestyle sounds impossible, but it is not. If you earn $100,000 after taxes, you must limit your lifestyle to $50,000 and save the remainder. This strategy will allow you to retire at age 65 with a lifestyle of $50,000.
Changing your lifestyle by spending less and saving more is always the fastest way to catch up from a slow start. Most important, it reduces the amount you must save to reach financial independence. Lowering your lifestyle is like traveling twice as fast and cutting half the distance you need to reach your destination.
Social Security can also provide a larger percentage of your retirement. If you are willing to retire on an average monthly income of $1,230, you probably don't need to save at all. But that certainly is not what any financial planner would recommend.
Start early and enjoy a more leisurely trip. But if you have delayed, don’t give up. Make a commitment to adjust your lifestyle as needed.
I often get comments like "It's too late for me to do this" or something similar. Granted, it's usually better to start financial efforts (saving, investing, growing your career, etc.) sooner rather than later so compounding can work for you. But it's better to start now rather than put it off any longer. And while you'll need to make sacrifices if you start late, it's not hopeless.
Knowing how much you should save for retirement is critical. But what if you are late getting started? The longer you delay, the shorter the time that compound interest can do its magic on your savings.
We typically recommend that you save 15% of your take-home pay each year. Money in the bank isn't compounding. Invest the money in an age-appropriate portfolio and rebalance regularly. Make sure your investments choices have low fees and expenses. Assuming you start at age 25, you should have sufficient assets to retire at age 65 after 40 years. Short-term market volatility should not deter long-term investing.
Retirement planning is like the pioneers who set forth on the Oregon Trail. The hardy souls who began their journey in early spring had to average 15 miles a day to reach their goal. But those who delayed until summer needed to maintain a faster pace. The same is true of saving for retirement.
Beginning at age 25 and retiring at 65, the appropriate savings rate is 15.4%. But starting just five years earlier, you could reach the same goal by saving just 11.1% each year. Starting early is more important than saving more.
If you start at age 20, you will have saved nearly an entire year's salary by the time the couple delaying is putting in their first 15%. In fact, the family starting earlier will be ahead of the family starting later all the way up until age 65. This is true even though they will be saving 5.3% less of their salary each year.
Deferred consumption is the definition of capital. When a family defers consuming and saves and invests instead, they put that capital to work. Having more money invested early means their investments are making money and adding to their savings, which reduces the amount they need to add. Money makes money.
Starting at age 15 is even better. For students who work summers and start saving, the safe lifetime savings rate is only 8.04%. Starting early is so beneficial that you can lower the rate you need to save each year. Thus every sage investor suggests beginning as young as possible.
Late April or early May was the best time of year to set begin the arduous trek to the West. If you waited too long, you would have to push farther each day or risk getting trapped in the mountains by an early snowstorm.
The same is true of retirement planning. The later you start in life, the higher the percentage of your lifestyle you must save. Starting at age 25 you should save 15.4% of your lifestyle each year to reach financial independence by age 65. For every year you delay, add about 1% in your 20s and 2% in your 30s.
Here's one of my favorite math problems: If a wagon train averages 10 miles a day for the first half of the Oregon Trail, how fast does it have to travel the second half to average 20 miles a day for the entire journey?
Most people wrongly answer 30 miles a day. But if the trail is 2,000 miles long, to average 20 miles a day you would have to travel the entire trail in 100 days. But if you averaged 10 miles a day traveling the first 1,000 miles, you would have already used up 100 days. You would then have to travel the second thousand miles instantly to overcome your slow start.
Starting at age 30, we suggest you save 21.4% each year. By age 35 it rises to 30.1%. And at age 40 it is 43.2%. Saving half your salary is difficult at any age. Lowering your standard of living to begin saving at age 40 is even more challenging.
By age 45 the percentage rises to 64.2%, and at age 50, you must save 100% of your lifestyle to reach retirement at age 65.
Saving 100% of your lifestyle sounds impossible, but it is not. If you earn $100,000 after taxes, you must limit your lifestyle to $50,000 and save the remainder. This strategy will allow you to retire at age 65 with a lifestyle of $50,000.
Changing your lifestyle by spending less and saving more is always the fastest way to catch up from a slow start. Most important, it reduces the amount you must save to reach financial independence. Lowering your lifestyle is like traveling twice as fast and cutting half the distance you need to reach your destination.
Social Security can also provide a larger percentage of your retirement. If you are willing to retire on an average monthly income of $1,230, you probably don't need to save at all. But that certainly is not what any financial planner would recommend.
Start early and enjoy a more leisurely trip. But if you have delayed, don’t give up. Make a commitment to adjust your lifestyle as needed.
Looks like I am well behind since I started at 26 and have only saved 6% up until recently. Although I am part of the new-age never retire crowd. This does not mean I am going to keep working, I am just planning a passive income portfolio.
Posted by: Adam Hathaway | October 10, 2012 at 07:00 AM
I like the Oregon Trail analogy and will likely use it when talking with clients about their children or even when I talk to younger clients.
Worth noting though is that there is research in the financial planning community that argues there are choices even in this basic decision on when to start saving. The alternative choice this research emphasizes is forgoing savings in order to raise lifetime income by increasing job skills. For example, putting a savings program on hold to pursue a higher academic degree or to study for a higher certification can make sense.
I also like the idea of young people starting a Roth if feasible.
Posted by: DIY Investor | October 10, 2012 at 08:01 AM
I'd rather save a lot early on and put it on cruise control the rest of the way to 65. I started at 21 and I'm cutting down now that I quit my job.
Posted by: retirebyforty | October 10, 2012 at 08:37 AM
If you understand the first critical fact about investing this topic is a no-brainer.
That fact is: "Learn and understand the Power of Compounding".
The second critical fact is "Don't Lose Money" since a 50% loss requires a 100% gain just to get even again.
Posted by: Old Limey | October 10, 2012 at 10:58 AM
I agree with most of this. The compounding interest, start early, etc. My issue is with this whole save XX% of salary theory. Income does not remain steady over time. We all should make more as our experience grows. As a result a significant portion of our savings do not benefit from compounding.
It is better to have a number, a goal that will give financial independence. I've have always saved at least 15% in retirement vehicles. I am now 48 and my portfolio is OK, but no where near where it needs to be. In a couple of years, when the kids are finished with college and the house is paid, we will be saving like mad to hit our number. Saving early has put our number within reach, but it will still take some effort to get there.
Posted by: Tim | October 10, 2012 at 11:05 AM
Good analogy. I just think that when you start later in life, the rules of the game are different and that's what you're stuck with. Call it a late entry penalty. So instead of saving a modest amount and putting it into an index fund returning 8% over the next 30-40 years, now you have to be more creative. Buy rental property, start a blog, create an e-product, live on less money, etc. There is always more than one way to succeed.
Posted by: My Money Design | October 10, 2012 at 12:04 PM
"Retirement planning is like the pioneers who set forth on the Oregon Trail."
ha. ...
"You have died of dysentery."
Posted by: Jim | October 10, 2012 at 01:21 PM
In order to accumulate a really large investment portfolio, at some point in your life you need to learn how to become a very smart investor. When I was fully occupied raising a family, working long hours to build my career, and spending quite a bit of money providing a good life for us and the 3 kids it wasn't possible to learn how to be a smart investor. In those days I also didn't have much money outside of our company IRAs and with those we had very limited control.
Our money didn't really start to grow fast until after I retired at the end of 1992 at the age of 58. That was when "investing wisely" became my primary interest and I put my all into it for several years. The amount of money we had when we retired amounts to only 4.5% of what our portfolio is worth today. A great help was that we both had company pensions, and then at age 62 we both took Social Security, minimizing the amount we have had to take out of our portfolio over the last 20 years.
Now examine the result of "smart investing" compared with holding Vanguard's S&P500 fund (VFINX).
From 12/23/1992 to 10/9/2012
VFINX .... ANN= 8.20%, Total Gain = 375.3%
Old Limey ANN=16.95%, Total Gain=2,113.5%
From 11/5/2007 to 10/9/2012 (The period I gave up trading and have been entirely in Bonds)
VFINX .... ANN=1.31%, Total Gain= 6.63%
Old Limey ANN=4.12%, Total Gain=22.04%
Admittedly, having 4 checks arrive every month is a huge advantage that fewer and fewer retirees will benefit from. My old company stopped the pension plan for new employees soon after I retired. My wife worked for the school district and they still have pensions and classified employees are still eligible for SS.
Posted by: Old Limey | October 10, 2012 at 01:34 PM