Safe Minimum Savings Rate?

Ok, before we talk about safe savings rates, we need to talk about the safe withdrawal rate.  So, here’s the problem financial planners face: how much money can they safely advise a client to pull from their portfolio for retirement living expenses, such that the client doesn’t run out of money before they die?*  Turns out that for most situations, it’s a 4% withdrawal rate.  Neat, huh.

So, the question Wade Pfau, an associate professor at the National Graduate Institute for Policy Studies in Tokyo asked was, simplified, “What is the safe savings rate?”  Or, what’s the minimum rate at which you have to save to meet your retirement income goals?  To do this, he linked the savings/accumulation period with the spending/decumulation period in such a way that it created a savings target.  Here’s a reproduction of the table illustrating safe savings rates:

FIGURE 2 – Safe Minimum Savings Rates
Replacement Rate = 50% of Final Salary
Retirement Phase
40/60 Fixed Asset Allocation 60/40 Fixed Asset Allocation 80/20 Fixed Asset Allocation
Accumulation Phase 20 Years 30 Years 40 Years 20 Years 30 Years 40 Years 20 Years 30 Years 40 Years
20 Years 31.98 39.50 47.02 30.94 35.91 38.92 30.52 34.45 35.94
30 Years 15.64 19.33 22.19 13.88 16.62 18.63 12.85 15.14 16.54
40 Years 10.26 12.42 13.84 7.57 8.77 9.22 6.26 7.39 8.06
Replacement Rate = 70% of Final Salary
20 Years 44.78 55.30 65.82 43.31 50.28 54.49 42.73 48.24 50.31
30 Years 21.90 27.07 31.06 19.43 23.77 26.08 17.99 21.20 23.16
40 Years 14.36 17.38 19.38 10.60 12.27 12.91 8.76 10.35 11.28
Table from Is There A Safe Savings Rate?” by Dan Moisand printed in July 2011 issue of Financial Advisor Magazine

If you can’t quite read the stuff on the right, click over to the original article at Financial Advisor Magazine.  The original table is there.

So what do you get from this?  When I see it, I get a little concerned.  The reason why is that, according to Profit Sharing / 401k Council of America, the average 401(k) participant saves between 5.5% and 7% of their salary in their 401(k) plan.  Do you see any numbers that are less than 7% up there?  I only see one, and that’s 6.26%.  That’s for saving over 40 years and replacing 50% of your income in a retirement only 20 years long, while in an 80% stock/20% bond allocation.  (Sorry about it being under the menus on the right.)

This is why financial planners can come off as harridans about saving money.  It matters so much for your comfort in old age, we can’t stress it enough.

Also, the old “save 10% of your income for retirement” adage will probably need to be rethought.  It will probably be alright if you start out young, are willing to take some risk over the long-term, and are able to keep at it uninterrupted for most if not all of your working life.  But, do you know anyone who lives like that?  The chances of a young person remaining employed over a lifetime, right now, look a little slim.  You can see above, if you take 10 years out of the savings period (say, one bout long-term unemployment (2 years), two family illness (4 years), and one failing business (4 years)) and now you have to significantly increase savings over a shorter savings period.  The chart gets pretty ugly, pretty quick.

*Technical terms: it’s a percentage of the investment that can be withdrawn per year for a period of time (adjusted for inflation) that will allow the portfolio to succeed 95% of the time.

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