How much should I be saving towards retirement?
This can be a very complicated discussion and there is no one answer. As you become more aware of matters personal finance and retirement, you will see competing views and differing opinions. But it’s important to note that no on recommends you stick your head in the sand and hoping that it all works itself out.
Regardless of your definition of retirement, only you can fund it.
We wrote this article to help you ensure that you are saving enough to build a reasonable retirement balance. Perhaps replacing your naive views that a couple of hundred rands a month into a unit trust will set you up good and proper for a retirement filled with lazy days and international travel.
Firstly, figure out how you want to live after retirement
A quick reminder that all investing should be goal-based.
You can’t just invest for ‘something’, or for ‘whenever’. This is because investing with a purpose, will reveal your time available to achieve your investing goal, your tolerance for risk, amongst other key variables, which all ultimately dictate the appropriate mix of assets classes for your investing needs.
It is asset classes mixed with the elapse of time that will explain most of your investment performance, so getting the appropriate mix is the real art.
Drawing this line in the sand means assigning some dates and numbers to the following:
- When you think you might retire?
- How old are you now?
- How much have you already saved?
- How much you want to retire with?
How much you want to retire with is best expressed as your income replacement ratio, which is: the percentage of your current salary that you think you’ll need in retirement.
Your income replacement ratio typically decreases in retirement, as you’ll probably have paid off large debt balances and your cost of living might have reduced as kids leave the nest.
Gimme a number
We can’t tell you what your income replacement ratio should be, but 70% – 80% would be a good start.
As a quick number to get this conversation started, if you were to save about 12% of your salary from the day you started working (assume 25), until the day you retire (assume 60), you should have enough capital to generate an income replacement ratio of about 75%.
In case the penny hasn’t dropped – that’s A LOT of money.
Hopefully you completed your expense tracking exercise and have some idea of what you spend and earn every month. If you are not currently saving anything towards retirement, we would like for you to please reduce your monthly take-home salary (after tax) by an amount of 12%.
Chop it off. Consider it gone.
Chances are you cannot afford that. Few people can afford to lose 12% of their salary every month and not have to cut-back elsewhere.
To make matters worse, 12% is a number that assumes that you started saving from day one. More likely that you’re like most of our readers who are 10, or even 20 years into their working lives and don’t have anything meaningful to show for their retirement savings.
Having delayed retirement savings well into your 30’s might require you to adopt a rate of savings closer to 20% or 25%, depending on your investing goals.
A quarter of your salary every month; that’s an incredibly large proportion of your salary to lose.
So what does that mean?
Well it means that if you’re like most people, you are underestimating the level of savings you need to work towards, to have any chance at a financially secure retirement.
The answer to righting the wrongs is both easy and incredibly difficult.
To some extent, we just helped you with the easy part – getting a sense of how much you need to save every month. To be certain though, set up an appointment with a financial advisor.
They will take the time to listen to you share your current financial situation, and then develop a financial plan to help you save towards retirement. They will be able to consider the four bullet points above and give you a more certain number to work towards.
That’s the easy part.
The hard part is finding the money to make it happen.
Time to get your finance game face on
If you accept what we and a financial planner might tell you, you now have to accept the very hard truth that you’re likely living beyond your means, and have been for a very long time.
Your ‘means’, should always be net of your required retirement savings, otherwise you won’t have the means for much, when you hit retirement age.
‘Living’ includes all those monthly expenses that make it seemingly impossible to scrounge together the 12% of your after-tax salary every month to make retirement happen.
Perhaps retirement saving is simply not a priority for you?
If you cannot find an extra 12%, or whatever amount you require, you need to understand that your financial life, as you’re currently living it, is not sustainable. It WILL unravel later in retirement.
If you cannot afford to put aside your appropriate amount of savings every month as determined by a financial planner, you’re effectively borrowing from your ‘retired self’. You’re living the life you want now, at the cost of a sustainable financial future when you’re no longer able to earn a salary.
Hey, that’s your decision, and nobody can stop you, just so long as you have full information at the time you choose to make these decisions.
At or near retirement
For some of you, the question is less about how much should I be saving going forward and more about how much should I have by now?
If you have something stashed away, it is fair to be asking, ‘Is it enough?’, or ‘Should I have more?’
Given that the time value of money works on an exponential basis and that everyone’s needs are different, it’s not as simple as saying, if you are 40 and you want an income replacement ratio of Y, then you need so much. Rather than waste your time, we’d rather that you get a professional advisor to do this calculation for you.
We can however say, that a common rule of thumb for figuring out what an appropriate amount to have at retirement, is to work on a multiple of your retirement salary, of 15 to 20 times.
If you were to retire tomorrow and you currently earned R250,000 p.a., you would likely need in the region of R3.75 million to R5 million. Relating this back to our initial percentage of 12%; if you were to save 12% of your after-tax salary, for a period of 35 years, you would end up with about 15 times your salary at retirement age.
These numbers assume a lot and it’s important to appreciate that what worked for an older family member, will not work for you. The world is a dynamic place. A 5 year boom period in equity markets, can make a radical difference in someone’s retirement efforts, just as easily as retiring in the midst of massive global recessions can cause mayhem.
Everyone is different. No single percentage can guarantee you anything, but it can go a long way, and probably enough of the way, to give you comfort.
If it were up to us
If it were up to us, we’d recommend you save anything between 17% and 20% of your salary every month. It sounds like a lot, but this is what would let us sleep at night.