Dear readers: Before we get to this week’s column about what percentage of your income to save, could you please help me with these two questions?
1. What should I buy my wife for her birthday?
2. I need some new shoes. What size should I get?
Wait, what’s that? You don’t have enough information to answer those questions? Exactly.
It’s easy to go online and find writers recommending that everybody save ten, twenty, or thirty percent of their income for retirement. Sometimes they specify gross income, sometimes net.
Either way, this advice is about as useful as recommending that everybody buy their spouse a necktie and wear 12EEE shoes.
One size fits some
Financial writers (myself included) often give advice with a particular type of person in mind: a professional who graduates from college, gets a job, earns a steady or rising salary throughout their career, gets married, buys a house, and retires at 65.
Why do we do this, even though the vast majority of people don’t have that kind of financial life?
Because it makes the math and the advice simple. Giving financial advice to this kind of model citizen is like giving basketball advice to LeBron: spend less than you earn, and try to put the ball in the hoop.
Job done, time for a coffee break.
Sure, I’m beating a straw man, and lots of financial writers address all kinds of difficult situations. But the quest for one savings rate to rule them all goes on. Here’s why the idea is doomed.
We don’t know how much money you make.
People who make more money can afford to save more money. A bold claim, I know.
But it’s true even on a percentage basis. Your taxes go up when your income rises; your spending on housing, food, health care, and other necessities doesn’t have to.
We don’t know how old you are.
A person just out of college is probably too busy paying off student loans to save for retirement, unless they have access to a 401(k) match.
Indeed, whenever you see handwringing about twentysomethings failing to save for retirement, remember that most people in their 20s don’t make much money, are less likely than older workers to have access to a 401(k) match, and tend to have student debt.
If they’re paying off debt, they are saving for retirement; it just doesn’t show up in their IRA balance as such.
We don’t know your goals.
Some people want a live-it-up worldwide cruise retirement. Some want to downsize or move to a lower cost-of-living town.
Expenses in retirement vary considerably, by choice and circumstance.
We don’t know your other circumstances.
Parents paying for college generally can’t afford to save much for retirement at the same time. An unemployed person can’t afford to save, period.
A person might reasonably choose to pay off their mortgage before saving for retirement.
We don’t know how much you’ve saved already.
A person in their 40s with no savings needs to save a lot more than an equivalent person who’s saved $500,000. Right?
We don’t know how your investments are going to perform.
Invest during a historically good 30-year period for stocks and you could come out with four times as much money as the person investing during a bad period.
Since you don’t get to decide when to be born and can’t predict the future, you have no control over whether you participate in the market during a good or bad time—and future market performance could be even better or worse than the most extreme historical periods.
It’s complicated, but…
All of this seems painfully obvious, although if it’s so obvious, why do people keep asking (and answering) the question?
Well, you have to save something. I always think of it this way: the money I’m saving for retirement doesn’t belong to me.
It belongs to a future version of me who will be really mad if I steal his money and probably has access to a time machine to come back and kick my butt, Terminator-style.
The best method I’ve come across for determining what percentage to save based on your personal circumstances is the Getting on Track formula, which I’ve written about in the past.
Start with your age and the amount you’ve saved already (as a multiple of your salary) and the formula will tell you what savings rate will let you retire at a particular age, even assuming historically bad market performance.
The formula isn’t perfect. It doesn’t take into account investment fees, unemployment, kids in college or living in your basement, or good news like an inheritance or profitable sale of a business. But it’s a reasonable start.
Real financial life is messy, because real life is messy.
Talk to any successful retiree and you won’t hear about how they locked in a 20% savings rate their first day on the job and stuck with it until their retirement day. You’ll hear about how the ups and downs of their life translated into periods of high and low savings.
That’s no excuse for failing to save when you’re able, and you’re probably able to save a little more, right now.
Now, if you’ll excuse me, I need to go back in time and tell my younger self not to dress like a slob.
Matthew Amster-Burton is a personal finance columnist at Mint.com. His new book, Pretty Good Number One: An American Family Eats Tokyo, is available now. Find him on Twitter @Mint_Mamster.