How much to save for the future is often the main reason clients come to us seeking help with financial planning. And it seems to be on everyone’s mind. When I talk with friends and family about finances, long-term savings is usually the topic du jour (though me being a financial planner no doubt encourages them).
What I’ve found through these conversations is that saving enough for the future means something different to everyone. People often use the more mainstream term, “retirement savings” to describe the amount of money they’ll use when they stop working (altogether or part-time) and live off the proceeds of their retirement portfolio. This can certainly apply to a lot of people, but not everyone needs to, or will, follow the traditional path of retiring at the age of 65. Some people will want to have the flexibility much earlier in life to stop working full-time. Others will want to take one or more sabbaticals at some point, maybe change careers one or more times.
Figuring out how to save for the long term is a complex problem to solve because there are so many factors influencing the outcome: your earnings over your lifetime, your timeline for how long you plan to work, other sources of income and support, your spending pattern or lifestyle, and unexpected life events. And of course no one can predict market returns or inflation rates decades into the future. Your best bet is regularly revisiting the question and tweaking your plan as life changes. Seeking out professional advice that puts your best interest above all else certainly doesn’t hurt either.
That all being said, there are a few steps you can take to see if you’re saving enough for your future self at this point in time. Below, we’ll take a closer look at how you can more accurately estimate a long-term savings goal, if it lines up with your long-term savings rate, and how to align your investment portfolio.
Assess how much you’d need to save
Given the loads of retirement calculators out there, I’ll do my best to keep things simple and lay out a few steps to help you roughly estimate your long-term savings target:
- Think about how much you plan to spend in the future when you’re no longer working. Consider what kind of lifestyle you’d like to have. Take a look at what you spend now and decide if you’d like to spend the same or differently in the future.
- Divide your future annual expense number by 0.04. This stems from the popular rule of thumb, the 4% safe withdrawal rate. This is just a guideline, but a lot of financial research has shown that a withdrawal rate of 3% to 4% from an investment portfolio is a safe amount to withdraw in your early years of retirement year while still allowing the portfolio to grow enough to last you. As an example, if you think you’ll have $100,000 per year of spending, this means you’ll need to have a $2,500,000 investment portfolio by the time you’re ready to start living off of it.
- Use a retirement savings calculator to get a sense of how much you’ll need to save. Nerdwallet has an easy-to-use tool. If you want to get more technical and play with the actual math yourself, the formula behind the retirement calculator tool is a PMT formula, and here is a great YouTube video on how to use this formula.
None of this is hard and fast science, because life isn’t linear like these formulas. If you want to stop working at age 45, you’re going to need a bigger nest egg and a more careful strategy of drawing on it in a way that preserves growth. If you plan to continue working for the rest of your life, even at a smaller part-time capacity, you will likely be able to get away with having much less saved.
Assess if your long-term savings rate lines up with your current savings
Once you estimate your savings target, check to see how well your current rate of saving lines up with it. How much per year are you putting into your retirement plan, like a 401k, or other savings vehicles?
Of course, life doesn’t work like the formula we just ran. The amount you can save and the amount you need to save will vary depending on life circumstances. Most normal people can’t just easily save $20k-30k or more per year, or whatever the “retirement calculators” wind up telling you to do.
In real-life financial planning, we often find that no matter who you are or how much money you make, saving somewhere between 15% to 25% of your annual income for the long-term is usually enough to set yourself up really well for the future.
Review Your Investment Portfolio
Finally, all these numbers won’t get far unless they’re invested in a way that yields our assumed rate of return of at least 6.5%. Check and see where you’re putting your long-term savings and what rate you’re getting.
For time horizons of 5 or more years, it’s usually a good idea to use investment vehicles like 401ks, IRAs, or brokerage accounts, and to invest your savings in a diversified mix of stocks and bonds. We wrote a previous post on what this strategy might look like.
Remember that, while it may be tempting, keeping long-term savings in cash would actually result in a negative rate of return of around 3% per year, reflective of the average annual inflation over time. A well-diversified portfolio of stocks and bonds, on the other hand, could be reasonably expected to yield a rate of return of somewhere between 6% and 10%, depending on how heavily it’s invested in stocks (growth) vs. bonds (stability). For example, the Vanguard Target Retirement 2045 Fund (VTIVX) has had a 7.72% average annual rate of return over the past 15 years. Target retirement funds like these are common options in employer retirement plans and are a bundle of many stocks and bonds designed to earn you steady portfolio growth between now and your target retirement date.
Saving for your future self is an ongoing journey that requires careful consideration, planning, and adaptability. By considering your age, estimating future expenses, assessing your savings rate, and reviewing your investment portfolio, you can do your future self a big favor by getting a firm handle on the health of your long-term savings strategy. Keep in mind that life is full of surprises, and your financial plan should be flexible to accommodate unexpected changes. It’s okay if savings fluctuate. Regularly revisiting these steps will empower you to take exceptional care of your future self and secure a wealthier, healthier future.
Brandon Tacconelli is the Director of Client Care at Thinking Big Financial, Inc. Thinking Big is a fee-only financial planning firm in New York City specializing in working with the LGBTQ+ Community.