Have you ever wondered how much you need to save to ensure a comfortable retirement?
Thanks to retirement researcher Wade Pfau, who used historical data to identify the so-called “safe savings rate,” we have an answer.
He investigated both the “maximum sustainable withdrawal rate” (MWR) and the “minimum necessary savings rates” (MSR) over all possible rolling 30 year periods between 1871-2010. And then he integrated these analyses.
His baseline case considered an individual that earns a constant real income over the final 30 years of their career, during which time they are also saving for retirement. All saving are deposited into a standard 60/40 portfolio comprised of large cap domestic stocks and short-term bonds, rebalanced annually.
Retirement then begins at the beginning of year 31 and lasts for 30 years, during which time this individual wishes to replace an inflation-adjusted 50% of their final salary via portfolio withdrawals. Seems low? Don’t forget about Social Security or the fact that you no longer have to save for retirement once retired.
Running the numbers
For starters, he sought to identify the lowest MWR over all possible 30 year retirement periods. This turned out to be 4.08% for the 30 retirement period experienced by a 1966 retiree, pretty much in line with earlier estimates.
As for the MSR, he shot for 12.5x the final year salary, corresponding to 50% of that income at the aforementioned 4% withdrawal rate (i.e., 50 / 4 = 12.5). The lowest MSR belonged to retirees in the class of 2000, who needed to save 10.89% of their income to build a portfolio 12.5x their final salary.
But these values can’t really be viewed in isolation, can they? As it turns out, high returns make it easier to build your nest egg, but periods with high returns are typically followed by decreased MWRs (due to lower returns going forward).
You thus have to account for that fact that any particular working period is coupled with a specific retirement period. When viewed in this context, Pfau found that an individual that consistently saved 16.62% of their income would have successfully financed their retirement over all possible time periods.
So there you have it. The magic number is 16.62%, which included possible employer matches. Of course, this is just one of many possible answers…
Tweaking the assumptions
If you change the underlying assumptions, the necessary savings rate changes. A longer accumulation phase decreases the savings rate. A longer retirement phase increases it. If you want to replace more of your income, the savings rate likewise goes up. And if you target a more aggressive allocation, it goes down.
Here’s a summary (click to enlarge):
One thing that really stands out from the above is the huge impact that the length of your accumulation period has on the results. Under the standard assumptions above, saving for an extra ten years decreases the necessary savings rate to 8.77%/year, whereas saving for 10 fewer years increases it to 35.91%/year.
In other words, if you’re not already saving for the future, get started today.
There are, of course, some important caveats. For example, to be consistent with existing research, Pfau excluded investment expenses when running the numbers. Such expenses reduce returns, and thus increase the necessary savings rate.
He also assumed constant (real) income over time, whereas most people earn less early on. This reduces the potential for compounding and increases the rate at which they’d have to save. And he assumed a constant (albeit intermediate) allocation, whereas most people reduce risk (and thus their expected returns) over time.
Regardless, there are some important lessons here.