Enough with the fluffy stuff, how about some firm numbers. Imagine that a young college grad actually has the forethought to even think about what they need for retirement. They check out an online retirement calculator, and see their needed amount is… 5.7 bajillion dollars!1 Shocked, they shake their head, walk away, and promise themselves to revisit it again in a few years… hopefully.
A more attainable goal: You should aim to accumulate double your salary by age 40. Doesn’t that sound more reasonable? This is the solution proposed by this Wall Street Journal article A $1 Million Retirement Fund: How to Get There From Here. (Thanks Don for the tip.) Why double?
Let’s say your salary has hit that $80,000, you have amassed $160,000 in savings, you are socking away 12% of your pretax income each month and your investments earn 6% a year. Over the next 12 months, your $160,000 portfolio would balloon to $179,518, or $19,518 more. Your monthly savings would account for $9,600 of that growth. But the other $9,918 would come from investment gains.
In other words, you’ve got to the crossover point, where the biggest driver of your portfolio’s growth is now investment earnings, not the actual dollars you’re socking away.
My only beef is that the math in the article is a bit vague. First, the article means double your expected salary at age 40, by age 40. Now, is the 6% assumed return supposed to be real or nominal? Are we assuming this is all in a 401(k)? How much inflation-adjusted money will this give you at age 65?
However, the main points remain. Money saved now will be worth a lot more than money saved later. Once you generate a “critical mass” in your retirement funds, they really do seem to gain a life of their own.
The graph on the right shows three investors, each of whom invests just $1,000 a year until age 65. However, one begins at age 25, investing a total of $40,000; one at age 35, investing a total of $30,000;
and one at age 45, investing a total of $20,000. Each earns 7 percent per year and, for purposes of this illustration, the effects of taxes and inflation are ignored.
The result? The early bird ends up with more than double the one who waits until age 35 and more than four times the one who waits until age 45.2
I’ve certainly experienced this. As our own retirement balances have grown, the recent stock gains alone are often thousands of dollars each month. So what are you waiting for? Get started with just $50 per month!
1 Actually if you plugged in 21 years old and $40,000, the goal would be $2,591,000. Still big!
2 Source: Investment Company Institute
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I start work in about two weeks and will be diving deeper into investments.
I don’t have many complaints about the article (after all, I suggested it). I noticed that the math was as you say: savings at age 40 amounting to double your salary at age 40. Still it seems like a really nice and tangible goal to keep in mind.
After all, if you have savings at age 35 amounting to double your salary at age 35, you can probably expect you are ahead of the curve. You can probably expect your savings to grow faster than your salary, given that it is earning a return and you are at the same time still contributing.
I’m a few years from 40 myself, and my savings aren’t double my salary, but I can well imagine that they will be close based on my contribution level and my approximate expected return. Naturally, that pleases me.
And if you reach 40 and find yourself behind, then you know what to do. You should probably look for a way to save more. At 40, you are young enough still to make modest adjustments and see big results in the end. It seems like a great age to lay down a guide post to see if you are on track.
To summarize, I think it is ingenious. It is mathematically simple, the measure is taken at a useful time of life, and it works for all income levels (at least according to the usual wisdom that your retirement income should be some percentage of you pre-retirement income).
I’ve heard this before, but I think the number was 1x salary by 40 rather than 2x salary. All the retirement calculators I’ve seen (except for this one) assume more than a 6% return, so at 7% to 9% return 1x income may well be plenty.
Furthermore, the rule doesn’t exactly apply to those with professional/doctorate degrees, as they (and me) get out of school later and often have a pile of debt (not me). This delay has to be made up through higher contributions as soon as a regular income becomes available.
I’m 38, have more than double my salary, put in 20% a year (thanks to matching), and still the Fidelity retirement calculator says I probably won’t reach my retirement goals by 65. What’s up with that?
While the idea is straightforward enough, I don’t know if it buys me much other than being “easy”.
As Bill Bailey wrote, doubling his salary doesn’t seem to get him over the hump. I advocate using a number of tools available to you in order to get a sense for whether or not you are on track.
I think that the Fidelity calculator is totally absurd. I’m in the same position as Bill and Fidelity wants us to bump our savings to 50% of gross. I think that calculator is “Fidelity’s Retirement Calculator.” 🙂
Your asessment of the article is spot on. My additional assumption is that the author intended any money you can tap for retirement to be included in the “double salary” figure… so if you buy a house (or are saving for a down payment), that money still counts because you can do a reverse mortgage or sell it in retirement. But money saved for a car, college… not so much.
Now, I’m not 40 yet, but I look to be on track by the article. I’ve also checked against the Fidelity calculator. According to the calculator, in average markets I could stop saving right now and be fine. In poor markets I’d run short.
But also according to the calculator, if I continue to save at approximately the same rate, I can expect to be fine in basically any market.
So to my eye the measures seem about on. I expect to have about double my salary at age 40, and the Fidelity calculator is laying pretty good odds that I’ll have enough retirement income. Perhaps the fact that most of my savings are in Roth accounts means more. After all, without tax at the end, that money can be expected to go farther.
I think that the secret to the Fidelity calculator is in the number that you can’t adjust. “Your goal represents assets needed to replace 85% of your pre-retirement income before taxes” Man, I wish I currently lived off of 85% of my income before taxes! After taxes and savings, I’m under 30%, so I’m not sure I’d even know how to nearly triple my spending in retirement.
Interesting article. I’m only 24, so even a goal for age 40 seems a bit intangable. The retirement calculators I’ve used just seem so abstract (can they REALLY estimate what I’ll need in 40 or 50 years!) so I basically just save as much as I can afford to. Which is good since I’ve only been working about a year and compounding interest is on my side–but after awhile, that strategey won’t be the best.
I am wondering if there is a calculator that can handle a change of investing strategy. For example, be aggressive when young and gradually switch to more conservative approach.
A noteworthy goal, indeed.
Of course, another goal could be to save half your net salary each year… Of course, the goal must be realistic and tangible, and will be different for everyone.
-Grant