Why the 10% saving rule doesn’t always apply

As you age, your financial requirements will change

Do these two nuggets of wisdom sound familiar? Save 10 per cent of your salary and invest your age as a percentage in bonds. If I have seen it once, I have seen it a thousand times and it annoys me every time anew. According to this maxim, if you expect to earn $50,000 this year, you should save $5,000. And, if you happen to be 40 years old, then you should have 40 per cent of the $5,000 savings, i.e. $2,000, invested in safe bonds and the remaining $3,000 in risky stocks. I think these two rules have the relationship backwards. First, your savings rate should depend on your age and stage in life. Second, how you allocate those savings across various investment choices should be based on your take-home pay and what you do for a living. As far as the stock vs. bond mix goes, age is less important than you think. Here’s why: When you are young and just starting out, you are likely earning much less than what you can expect decades from now when your career will mature.

Saving 10 per cent, 5 per cent or even 1 per cent of your salary could be nearly impossible.

You have student loans to pay, a household to set up and perhaps a mortgage or car loan to juggle. Committing to rigidly save a fixed percentage of your salary can really hurt.

The short-term psychological cost — being unable to enjoy life today — may be a lot higher than the utility or enjoyment of some distant nest egg.

Decades into the future, in your 50s perhaps, you will be earning more per year and a large fraction of your debts will have been worked off. Then, in fact, you can likely afford to save much more than 10 per cent, perhaps 20 per cent or even 25 per cent. Either way, personal saving rates should be adjustable, like a thermostat, and take into account your age and stage in the financial life cycle.

So,10 per cent might be too high or it might be too low. My problem isn’t with10 per cent. My problem is with a number.

Moreover, when it comes to asset allocation and the ‘investing your age’ rule, there are more important factors than how old you are. These include how much you are earning this year relative to your total wealth, what you do for a living and the security of your career.

The objective of strategic personal financial planning is to enjoy a relatively constant standard of living over time

If the $50,000 you are earning comes from a safe, secure and stable career, then your bond-like job should be taken into account and you can afford to take more financial risk. On the other hand, if the $50,000 is from work as a contractor, or real estate agent, or some other vocation sensitive to the volatility of the economy, you should take less financial risk with your investment savings and hold more bonds. Age is only a minor player in this equation.

The financial advice industry focuses too much attention on savings rates as a per cent of this year’s salary or take-home pay and not enough attention on your lifetime earning power and consuming that money in a smooth manner over your life cycle.

Is the objective to be “poor” for 25 years, so that you can be “rich” for 25 years? It seems like starving yourself today so that you can binge tomorrow.

The objective of strategic personal financial planning is to enjoy a relatively constant standard of living over time, or perhaps one that increases slightly as you age. The objective isn’t to deprive yourself for the first two decades of your working life, just for the sake of creating a big piggy bank for the last two decades. All the more so when your piggy bank isn’t earning very much these days.