By: Steven Podnos, MD CFP, a financial advisor on NerdWallet’s Ask an Advisor.
Joe and Beverly Simpson drove home quietly after an initial meeting with a new financial planner. They had felt optimistic and happy before the meeting. But then the planner asked them, “How much have you saved, and how much are you saving?” As a team, they realized that with only about 10 years to a planned retirement, they were very unlikely to be able to live as they had been doing. Their optimism had evaporated as they looked at their saving and spending habits.
We all wrestle with how much of our income to save. Some of us are inherently frugal, some are inherently the opposite, and many of us are in the middle. How do we decide how much to spend?
With the many families I work with, I see a variety of patterns. Some spend too little (yes, really) and some too much. I suspect the general population that does not use a planner tends to err on the “spend too much” side.
Some people like to spend money on cars, some on fancy homes, and some on travel. For some, clothes are worth it. I’ll say here that I don’t think it matters what we decide is worthy of expense. We all have the absolute right to determine the best ways to spend our own money.
So, it really comes down to how much not to spend. I recommend that you should be saving enough to be relatively certain that you have “enough” for the time that your earned income stops. “Enough” is a lump sum that allows a roughly 4% distribution rate (for most families) that can satisfy the desired lifestyle income in retirement after considering Social Security and other potential sources of income (rental property, other pensions, etc.).
“Enough” means that you are accumulating funds annually that are likely to grow at a reasonable rate of earnings so that at the end of your working career, you’ll have the funds you need. This amount of savings is radically different for each family. Someone earning $250,000 a year and living on $100,000 a year will save “enough” quickly. Conversely, the same individual saving 10% (or $25,000) a year will need to do so for a very long time. So understand that the savings is not an absolute number, but better expressed as a percentage of income.
If I had to pick an approximate percentage of income that most families should try to save, I’d pick 20%. I know, this sounds like a lot, and perhaps 15% will be enough if you start early in life. If you are reaching middle age and have not been saving enough, you might check in with a financial planner to examine how much you need to catch up.
I’d say without question that saving enough is much more important than how much you make on your savings. Unless you are investing irresponsibly, your returns will reflect how the markets you invest in do. What really matters is how much you save and how early you start.
And if you’ve taken a good hard look at your numbers, and you’re comfortable you’ve hit that sweet spot of saving “enough,” knock yourself out and enjoy the funds you do spend!