Adjusting Your Savings Goals

How much do you need to have saved up before you retire? The answer to that question used to be pretty straightforward. With $1 million in savings, at a 5% interest rate, you could be reasonably assured of having $50,000 in annual income by investing in long-term bonds and simply living off the income. With $2 million, you could expect to have a six-figure annual income without having to dip into principal.

Unfortunately, interest rates have been on a steady decline for roughly three decades now. Back in 1980, nominal Treasury bill rates were roughly 15%, but these days a 30-year Treasury is yielding just under 3%. Lower bond yields have made the investing equation in retirement more difficult, and it was only exacerbated by the credit crisis, which also served to complicate the way in which individuals save in order to have enough to live off in retirement.

Key Takeaways

  • Investing a chunk of money in long-term bonds is no longer the road to a secure retirement that it once was, given the decline in bond yields and the fallout from the 2007–2008 credit crisis.
  • Knowing how much to set aside in a 401(k) requires having a savings goal and taking into account your current status, including your age, savings, and projected retirement age.
  • Take rules of thumb with a grain of salt—such as the 10% rule for retirement savings and determining the percentage of bonds in your asset mix by your age.
  • Use an online retirement calculator to help you see how altering your input translates into a higher or lower retirement nest egg.

Set a Savings Goal

The primary savings vehicle for most Americans these days is a 401(k) retirement plan. Traditionally, retirees have been able to count on Social Security—and they still can—but the long-term outlook for this government benefits program is complicated by changing demographics, and it was never intended to supply everything someone would need to fund their retirement. All of this makes it more important than ever for workers to save as much as possible for retirement.

Deciding how much to save first requires having a retirement goal in mind, such as an overall savings level or an annual income target like the ones mentioned above. Given your goal, you can attempt to reverse engineer—or back into—a current level of savings. You should also include your current age, current savings levels, and estimated retirement age in your calculations. Other major inputs consist of estimating market return levels, such as the growth rates of stocks, bond interest rates, and inflation rates over the long term.

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Consider Rules of Thumb

Given the many variables, it may help to consider general rules of thumb to determine savings levels and percentages. Saving 10% of one's annual pre-tax salary, for example, has generally been considered an adequate saving percentage. However, because people are living longer and don't want to run out of money in their eighties or nineties, a savings rate of 15% or even higher has been proposed. A higher rate can also benefit those who didn't start saving in their 20s and are now trying to catch up. Employers generally do match at least a few percent of what their employees contribute to a 401(k), which can help in getting to a double-digit annual percent.

In terms of estimating market returns, real returns on U.S. stocks have averaged around 7% over the past century. Real bond return levels have been much lower at 2%, while returns on short-term funds have been around 1%. Clearly, any asset growth will have to rely on stocks and a diversified portfolio of similarly risky assets such as venture capital, real estate, or private equity.

A common rule regarding asset mix is that the percentage an individual should invest in bonds is equal to their current age. Although this allows for a gradual progression to living off interest income at retirement, there is little need for a 20-year-old, who has many decades to ride out stock market volatility in pursuit of real returns, to have even 20% invested in bonds.

The Savings Lifecycle

Many websites, including Bankrate and the nonprofit organization AARP, provide retirement calculators to help you enter and tweak the key variables to come up with annual savings goals.

Using Bankrate's 401(k) savings calculator and the inputs listed above, here is a summary of potential savings levels from when someone starts working to when they reach retirement.

Primary inputs include a modest starting 401(k) balance of $1,000, 22 as the age at which the employee starts working, a starting salary of $40,000 that grows at 3% per year (roughly the projected annual inflation rate), a 10% contribution rate (or initially at $4,000), a retirement age of 67, and annual portfolio return of 8% per year. Additionally, since an employer match is common, it has been figured in with a projection that it matches half of the first 6% the employee contributes.

When you use an online retirement calculator, the value of your employer's matching contribution to your 401(k) becomes abundantly clear. Make sure you contribute enough to get the full match.

With these inputs, including a disciplined contribution rate and steady average market returns for more than four decades, this worker would be sitting pretty at age 66 with a total account balance of nearly $3.1 million. You can see why an employer match is a big deal, as without it the ending balance would be a more modest $2.4 million—although that's still plenty to live on. With the employer match, the balance would exceed six figures when the employee hit age 32, surpass a half million by age 46, and pass a cool million by age 53. By age 61, the balance would exceed $2 million.

You can tinker with online calculators like this one to see how changing your inputs—age, salary, contribution rate, portfolio return rate, and more—will alter the amount you can expect to have when you retire. Then comes the hard part of actually saving.

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The Bottom Line

At the end of the day, setting aside as much money as you can and investing it prudently are two conditions generally under your control as a saver. Of course, you also need to live within your means and either stay current on financial markets or hire a trusted investment advisor. Staying mindful of investing rules is also helpful, as is a little bit of luck—as in periods of above-average stock market returns or bond rates, such as those that occurred in the 1980s and through most of the 1990s, as well as the bull market in stocks, which began in March 2009 and has now run for more than 10 years.