In a prior article we wrote a while back, we talked about how much you might need to retire. The focus then was on how much you might need one day, or at least how much you should be saving every month now, to achieve a viable chance at what the financial services industry literati judges to be a dependable retirement lumpsum.
Given that many of you are well into your working careers, you want the hard truth as to how much you should have saved by now, to be on track towards your retirement planning.
Before we get to the numbers below, let us recap a few important truths about retirement saving.
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, among other key variables, which all ultimately dictate the appropriate mix of assets classes for your investing needs.
The table that we’ve prepared below is based on assumptions. Your retirement goals drive these assumptions.
We had to choose some assumptions which we thought were reasonable in preparing this data, so we went with the following.
- We figured that you might want to retire at age 60, because there is more to life than cubicles
- We’ve also assumed that your money would last you between 25 and 30 years after retirement
- Your salary will go up every year from now, by about inflation +1 or +2%
- You’ll achieve an investment return of about 12% per year (gross return – meaning that inflation will still take a piece of it)
- Inflation will be about 6% going forward
- We’ve worked on an income replacement ratio of 70% (See below)
- That you’ll save 12% of your pre-tax monthly salary towards retirement
- Your retirement lump sum multiple at retirement is about 15 times your income replacement salary and about 10 times your gross annual salary.
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 (like your house bond) and your cost of living might have reduced as kids leave home.
Example: You currently earn a gross salary of R40, 000 per month (before tax). With an income replacement ratio of 70%, this means that you’d be comfortable retiring on income of R28, 000 per month (in today’s Rand equivalent) – obviously in 20 years’ time, R28, 000 won’t be enough for an iTunes movie rental.
But I’m skeptical of your assumptions
Changes to assumptions can make the results vary quite a bit. You may think that you cannot live on an income replacement ratio of 70% and that only 90% will do . This would mean that you would need a considerable amount more at retirement than we have calculated. Likewise, if you’re able to save a lot more than 12% per month, you’d end up with a lot more at retirement, which would mean your income replacement ratio could be higher, or you could keep it the same rate, and make your capital last a lot longer than 25 years.
We reckon that if you customized this model to your own needs, you would increase some variables and decrease others, and let’s for the sake of getting to some sort of conclusion, agree that you might end up in the same place.
In fact, we’re such nice people that if you email us, we’ll run a customized version of this model just for you and your particular circumstances. How’s that!
So without further delay, we present…..The Numbers. (Please excuse its appearance – we don’t pretend to be graphic designers.)
How the table works
Find your nearest current age down the left hand side, then find the block to the right of it; this will be ‘your multiple’. This is the multiple of your current, before-tax salary that you should currently have saved towards retirement in order to be on track.
I am 40 years old and currently earn a salary of R500, 000 p.a. My multiple is 2.6 times. This means that with my salary of R500, 000 p.a, I should have a current lumpsum of about R1.3 million.
As this table is based on assumptions and everybody’s personal financial circumstances are different, this table is not, and cannot be infallible. For instance, you could change careers or shift jobs and suddenly you have more money every month; this table doesn’t cater for that.
But don’t let the fact that some of these assumptions might not gel with your expectations as to what the rest of your working life might look like, put you off listening to what it’s telling you. The general themes are sound and you’d do well to heed the sums.
So what can I take away from this table?
The learning from this table is potent; make no mistake.
Let’s take the example of Chris. If you remember Chris from our article on compounded returns, you’ll remember that Chris was the guy that nobody knows, but should you by chance one day meet him, he’ll leave you feeling pretty miserable about your prior financial decisions. That’s because Chris was a diligent saver and has been putting cash away since his first salary. Chris is now 45 years old and is selling his soul at a large law firm, advising clients on Competition Commission applications and pulling in a tidy sum of about R800, 000 p.a.
Based on his table multiple (3.9), Chris should have saved about R3.1 million, but in reality, Chris has saved closer to R4.3 million. This now gives Chris options. He could scale back his monthly contributions to his retirement savings, look to retire earlier one day, or consider a higher income replacement ratio upon retirement.
Let us not forget Bill. Unlike Chris, Bill spent his earlier working years accumulating artisan gin bottles and thought that life experiences trumped cash in the bank. Bill is about the same age as Chris and does not earn as well as Chris. Bill currently earns about R500, 000 p.a.
Based on his table multiple (3.9), Bill should have about R1.95 million to his name. Bill currently only has about R375, 000 saved up.
Bill has some serious decisions to make about how he chooses to spend his money over the next several years. Bill is facing a massive gap in his retirement savings. To address this shortfall, he could increase his monthly contributions to some tax-deferred savings vehicle, increasing perhaps to as much as 20%. He might have to consider the possibility of retiring at a much later age, or alternatively, agreeing to accept an income replacement ratio less than the 70% that this table works on.
Remind me again what it means to retire?
The beauty about all of this, is that if you buy into the assumptions, which we’ll add are all sane, appropriate, and honest, then you have to buy into what the table is telling you.
We do get that retirement does mean different things to different people, and that leaving formal employment at age 60 might not be your idea of retirement in which case you could be inclined to think we’re rambling on about a bunch of stuff that doesn’t apply to you. This may be so, and yet it might not.
We think we were pretty clever way back when, when we put this article together in which we talked about the meaning of retirement. We thought that one of the better definitions of retirement (with our personal finance hat on), was to think of retirement not as a thing we one day do, when we no longer earn a salary.
Rather, we thought it better to think of retirement not as what you do when you stop working, rather it’s what you do when you’re no longer able to work.
This introduces the idea of retirement as an event which is not within our control, and rather something that we should insure against. How does one insure against not being able to earn income?
And that is what this table does for you. It helps you find that number now, that lets you know if you’re on track to insure yourself against not being able to earn an income one day, and just how far off you might be.
We wanted this article to give you a quick snapshot as to where you should be with your long-term saving, however the more we wrote, the more related topics came up; “what is retirement?”, “the idea of compounded returns”, things we didn’t even write about like “compounded costs that add no value”.
We can’t get into all of these things in this article, but if you’re one of your newer readers at WellSpent, the best advice that we can give you is to start at the beginning. Some of our earlier articles form the foundation of all our future writings on personal finance, so you’d do well to go through them – they’re not boring I promise.
So what does this all mean?
- Don’t underestimate the level of savings you may need one day if you want any chance at a financially secure retirement
- Seek professional financial advice if you think you need it
- Long-term retirement saving is meant to be boring
- You may be living above your means and remember that 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.
- You cannot argue with mathematics