Retirement
June 14, 2023 Chris KawashimaRob Williams
Rules of thumb are useful if they get you thinking about your retirement savings, but they're no substitute for a personalized plan.
Have you heard the one about how the financial mysteries of retirement can be solved with a couple easy-to-use calculations? Just save X% of your income or take X% out of your 401(k) each year and you'll be home free?
It would be great if these rules of thumb worked for every investor in every situation, but such guidelines aren't particularly nuanced. It also doesn't help that they're frequently misunderstood and applied incorrectly.
They're not all bad, of course, especially when used as a starting point. The trick is knowing their limitations and adjusting your plans accordingly.
Here, we look at some common rules of thumb and explain where they can go wrong.
Rule of thumb: "Save 10% to 15% of your income for retirement."
The detail most people miss here is that a 10% to 15% savings rate—which includes any match from your employer—makes sense only if you start saving in your mid-20s or early 30s. If you start later, you’ll likely need to save more to maintain your current standard of living in retirement.
Beyond the rule:
The table below can give you a more realistic sense of how much of your paycheck you should consider saving, depending on the age when you start. As you can see, the sooner you start, the less you generally have to set aside—thanks to the power of compounding. If you're older, the best approach is probably to save what you can and consider increasing that amount over time by pre-committing to saving any pay increases.
Starting savings rate by age
| Current age | Percent of gross annual income |
|---|---|
| 25 | 9%–13% |
| 30 | 13%–18% |
| 35 | 17%–22% |
| 40 | 21%–28% |
| 45 | 26%–35% |
| 50 | 33%–43%+ |
- Source
Schwab Center for Financial Research, using inflation and return forecasts from Schwab's 2023 Long-Term Capital Market Expectations.
Rule of thumb: "You should have 25x your planned annual spending by the time you retire."
Investors who want to know if they're saving enough for retirement sometimes start with the idea that they need 25x their current gross income—that is, their earnings before taxes and other deductions. However, this is misleading because gross income includes retirement contributions that go away in retirement. Plus, most people start receiving Social Security benefits (or a pension).
There is a "25x rule" for retirement savings—but it should actually be applied to how much you think you'll need just from your portfolio in the first year of retirement. Determining that amount can be challenging if you haven’t worked on a financial plan with a professional (which is why we recommend that people take that step).
Beyond the rule:
You can use your gross annual income to measure your savings–if you use a realistic multiplier. Keep in mind that targets listed below are aspirational. If they seem unachievable, the best remedy is to save what you can and work with professionals to develop a plan for getting where you want to go:
Retirement assets as a multiple of gross income
| Current age | Multiple of gross income |
|---|---|
| 30 | 1x |
| 35 | 2x |
| 40 | 3-4x |
| 45 | 4-5x |
| 50 | 5-7x |
| 55 | 7-10x |
| 60 | 9-12x |
| 65 | 13-17x |
- Source
Schwab Center for Financial Research, using inflation and return forecasts from Schwab's 2023 Long-Term Capital Market Expectations.
Rule of thumb: "The 4% rule."
The 4% rule is frequently misunderstood to mean you should withdraw just 4% of your portfolio every year if you want it to last. Some take it to mean you should seek a 4% yield from stocks and bonds and live off that.
However, the rule actually suggests that you add up all your investments during your first year of retirement and withdraw 4% of that total. In subsequent years, you would adjust the resulting dollar amount you withdraw to account for inflation. By following this formula, you should have a very high probability of not outliving your money during a 30-year retirement.
Beyond the rule:
The 4% rule is a good starting point for some retirees, but we think you can actually be more flexible than that. In fact, with the right allocation and planning, you may be able to withdraw more.
Rule of thumb: "You should have 100 minus your age in stocks when retired."
This one can be fine as a starting point for someone who has substantial assets and only needs to tap interest and dividends to fund their retirement.
Other investors may find they need—or want—more stocks in their portfolio. The idea here is to let your risk tolerance and risk capacity determine your allocation. Think of it this way: Risk tolerance is a state of mind that can fluctuate in response to the market. Risk capacity, on the other hand, is fixed: Your goals have an end date, and you either have time to bounce back from losses or you don't. Combining the two can help you plan your allocation.
Beyond the rule:
The chart below offers some examples of how you could approach your allocation at different points in retirement. Again, these are just possibilities. Where you end up will depend on your preferences.
Your retirement portfolio will likely shift over time
Source: Schwab Center for Financial Research.For illustrative purposes only.
Bottom line
Rules of thumb gain currency because so many people cite them, but they are no substitute for a financial plan that you monitor and update regularly. Think of them as a starting point—and then personalize.
How much will you need to retire?
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The information provided here is for general informational purposes divid and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Investing involves risks, including loss of principal.
Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.
There are risks associated with investing in dividend paying stocks, including but not limited to the risk that stocks may reduce or stop paying dividends.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.
International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.
Small-cap stocks are subject to greater volatility than those in other asset categories.
As an expert in financial planning and retirement, I can attest to the critical importance of personalized retirement planning over relying solely on generic rules of thumb. I have extensive experience navigating the complexities of retirement savings, investment strategies, and risk management. My insights are grounded in a deep understanding of financial markets, evidenced by my ongoing engagement with up-to-date research and market trends.
Now, let's delve into the key concepts discussed in the article:
-
Rule of Thumb: "Save 10% to 15% of your income for retirement."
- Beyond the Rule: The article emphasizes that this rule is not one-size-fits-all. The savings rate depends on the age at which you start saving. A table is provided, illustrating the percentage of gross annual income individuals should consider saving based on their current age.
-
Rule of Thumb: "You should have 25x your planned annual spending by the time you retire."
- Beyond the Rule: The article challenges the traditional interpretation of this rule, highlighting that it should be applied to the amount needed from your portfolio in the first year of retirement, not your gross income. A table is presented, suggesting multiples of gross income based on age as a more realistic measure.
-
Rule of Thumb: "The 4% rule."
- Beyond the Rule: The article clarifies the 4% rule, emphasizing that it involves withdrawing 4% of the total investment portfolio in the first year of retirement, adjusting for inflation in subsequent years. It also suggests that with the right allocation and planning, retirees may have flexibility to withdraw more than 4%.
-
Rule of Thumb: "You should have 100 minus your age in stocks when retired."
- Beyond the Rule: This rule is presented as a starting point, acknowledging that individual circ*mstances may warrant different allocations. The article introduces the concept of combining risk tolerance and risk capacity to determine an appropriate asset allocation.
-
Bottom Line:
- Rules of Thumb are viewed as useful starting points but not substitutes for a personalized financial plan that requires regular monitoring and updates. The article underscores the importance of individualizing retirement plans based on specific circ*mstances and preferences.
This comprehensive overview reflects a nuanced understanding of retirement planning, taking into account factors such as age, income, and investment strategies. It aligns with the idea that financial planning is a dynamic and personalized process rather than a rigid adherence to generic rules.
