How much do I need to save?
A rule-of-thumb way to figure out how much you should save is to estimate how much you think you’ll make over the course of your working life, make a safe guess at how long you might live and come up with a spending rate based on the ratio of the two.
The example below is very simplistic because it ignores interest, and the fact that you have no way to know how long you will live; but it gives you the main idea.
You are 45 years old, haven’t saved a dime and earn $75,000 (after tax) per year. You expect your income to remain constant in inflation-adjusted terms until age 65. So, your total expected income to retirement: $75,000 x 20 years = $1.5 million. You figure you’ll live to age 90 maximum, so you have a total of 45 years where you need money of which in 25 of them you aren’t working. Average spending rate until age 90:
Divide $1.5 million by 45 years and you get $33,300. That’s the average amount you can spend each year and still be able to live in retirement with the same standard of living.
So, you have to save $41,700 this year. That is $75,000 — $33,300, which is over 55 per cent of your salary. How likely is that? Not very. But if you save any less you will have to reduce your standard of living at some point in the future.
This is quite simple — and ignores a whole host of factors — but is a good example of where saving 10 per cent of your income isn’t enough by a mile.