The Problem With Saving 10% of Your Paycheck

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"Save 10% of your paycheck." This money chestnut handed down through the ages gives the impression to those who follow it that they'll be just fine by the time they retire. Too bad it's not true.

What's missing from the 10% rule of thumb is this vital footnote: "... As long as you start by age 25 and never stop saving 10% of every dollar you earn until age 65."

But that's not what most of us do. Instead, we buy our homes and cars and put the kids through school, and then -- after a few vacations, home renovations, and transmission overhauls -- we finally get serious about saving for the future.

And what does that leave us with in retirement? Not nearly enough.

Who's really picking up retirees' tabs?
Every year, the Employee Benefits Research Institute (EBRI) asks workers what they expect will be the major sources of their retirement income. Then EBRI then compares their expectations to the actual experience of current retirees.

Our willingness to pay for our own futures is admirable: In the 2009 survey, the majority of workers (60% to 75%) indicate that they expect to cover the bulk of their retirement expenses from their own savings (including employer-sponsored retirement savings plans, IRAs and other personal investments). And 81% indicate that Social Security will cover some part of their expenses, too.

You might not want to be too quick to reach for the tab: 92% of retirees report that Social Security is the major source of their income. And how much do they rely on personal savings to pay their expenses? Less than half say that money they socked away (in 401(k)s, IRAS or other investments) helps them pay the bills. And 58% rely on income from a pension.

So the question then becomes, how confident are you that Social Security will be around to support you during your dotage? And what about income from a pension? Do you even know of any employers in your field that offer pension plans anymore?

That brings us back to that 10% savings rule of thumb.

So how much should you really save?
We all know we should be saving more ... but less than half of us (46%) have even tried to figure out how much we'll really need by the time we retire, according to EBRI.

If you're a savings late-bloomer, you might want to brace yourself before this next paragraph. Ready?

A study in the Journal of Financial Planning revealed that a 45-year-old will have to sock away twice as much as a 25-year-old to enjoy the same lifestyle in retirement. Wait until age 55, and you're looking at some major belt-tightening -- saving three times as much per paycheck as the young whippersnapper in the next cubicle. Oof.

Four ways to be a smarter saver
You don't have to scale back to ramen noodles and take in renters to turn your future around. Remember, the amount you save is just one part of the equation. Yes, you should save more. But saving smarter is even better. Here are three strategies that'll help you play catch-up quickly.

1. Milk your workplace for every cent you can
Contributing to employer-sponsored 401(k) and 403(b) plans with matching offers an instant savings boost. A 25% match (the equivalent of two-year market-beating returns just for showing up) turns a $5,000 contribution into $6,250. If you're 50 or older, take advantage of yet another break -- a tax break -- via the catch-up contingency, which lets you sock away as much as $22,000 in pre-tax dollars.

But even if your employer doesn't offer a match, remember, your contributions to a 401(k) (or a traditional IRA) lower your taxable income. So you pay less in taxes now, and the money you sock away grows tax-free until it's time to start using it to cover retirement expenses.

2. Get paid by Mr. Market
We know it's been a bumpy ride. But if you're decades away from retirement, the stock market is the best place for your savings. The same holds true even if your retirement party is next week. Don't quit the stock market once you hang up your suit and tie. Give the money you don't need in the next five to 10 years room to run without risking it all on highfliers.

Consider this oft-overlooked footnote about the stock market's historical 10% annual return: 6% comes from capital appreciation, and 4% from gains from dividends. Late savers can improve their lot with less risk with investments carrying above-average dividend yields. Many popular stocks, including Coca-Cola (NYSE: KO  ) , PepsiCo (NYSE: PEP  ) , and Procter & Gamble (NYSE: PG  ) , have yields at or near 3%. Even stocks like General Electric (NYSE: GE  ) , which cut its dividend last year, still yield more than 2%.

3. Make the most of all your assets
You can work in retirement, or you can make your assets do more of the heavy lifting. Annuities and reverse mortgages -- two strategies regularly covered by my colleague Robert Brokamp at the Motley Fool's Rule Your Retirement service -- can be lifesavers to cash-strapped retirees. But they are complex vehicles, best not entered into lightly.

4. If nothing else, come up with YOUR savings rule of thumb
Remember, the 10% savings myth is at best an oversimplified starting point (and, at worst, it could lead you to make some critical miscalculations about your long-term financial health). The best retirement gift you can give yourself is to see if your current savings strategy is roughly on track. Use the calculators in our Retirement Planning area to get rough estimate of how far your current savings will take you in your golden years.

If you need a second set of eyes and some personal guidance on customizing your retirement plan, the Garrett Planning Network -- a group of fee-only financial advisors (the only kind The Motley Fool recommends) -- is offering a limited-time, 10% discount for new Motley Fool clients. Use this map to search your state, and look for The Motley Fool icon to identify participating advisors.

Dayana Yochim was no child savings prodigy, but she's made a valiant effort to overcome her youthful discretionary overspending. Coca-Cola is a Motley Fool Inside Value recommendation. Coca-Cola, PepsiCo, and Procter & Gamble are Motley Fool Income Investor picks. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Procter & Gamble. Dayana holds none of the companies mentioned in this article in her portfolio -- a fess-up required by the Fool's disclosure policy.

Read/Post Comments (8) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 06, 2010, at 4:11 PM, rlp2451 wrote:

    After working for 37 years, and saving even more than 10% per year, AND taking advantage of company-match, AND opening IRAs, after the last two years I feel like I am no further ahead than I would have been had I not done so. The fallacy of save save save is a myth.

    Show me a mutual fund that has increased as much as the Dow has in the past year and I can show you 1000 that lost 40-50% that have never recovered from the 2008-09 crash.

    Unless you are a hedge fund manager, banker, or politician, you will not have gotten rich by this 10% method.

  • Report this Comment On April 06, 2010, at 4:20 PM, tdirham wrote:

    Dayana Yochim, with all due respect, your calculations are way off (foolishly so). As an oversimplified example omitting compounding if a 25 year old saved $100/mo for 40 yrs (age 65) that would be $48,000. If the 55 yr old saved only THREE times as much as you suggest, that would be only $300/mo for ONLY 10 years (age 65); this amounts to only $36,000, far less (25%) than the 25 yr old. In addition, when you include 40 years of returns and appreciation the divide would grow to immense proportions.

    The 25 yr old has FOUR times as long to save for retirement (age 65) as the 55 yr old. Suggesting that a 55 yr old can make up for that four-fold difference in outlook with only a three-fold increase in savings is truly foolish.

  • Report this Comment On April 06, 2010, at 4:52 PM, senorbum wrote:

    Yeah, the math/statistics in this article truly are awful.

    Also, rlp2451, thats why you go with index funds if you aren't in to tracking the market day in and day out. They have lower fees and will follow the market as you are expecting. Seems like you are bitter for not doing homework before you invested money.

  • Report this Comment On April 06, 2010, at 4:53 PM, senorbum wrote:

    Yeah, the math/statistics in this article truly are awful.

    Also, rlp2451, thats why you go with index funds if you aren't in to tracking the market day in and day out. They have lower fees and will follow the market as you are expecting. Seems like you are bitter for not doing homework before you invested money.

  • Report this Comment On April 06, 2010, at 5:24 PM, tdirham wrote:

    As I was thinking more about how badly this article misrepresents the plight of the 55 yr old, I thought I'd post a quick comparison with ROR included:

    To reach $3 million at age 65

    ROR | 25YO $/mo | 55YO $/mo | Multiple

    5% | $1966 | $19,320 | 9.8X

    7% | $1143 | $17,333 | 15X

    10% | $475 | $14,665 | 30X

    (that's no typo, 30 times, not 3 times)

  • Report this Comment On April 08, 2010, at 10:37 AM, TMFKris wrote:

    The headline make me think ... Sometimes saving 10% of your paycheck is a problem because you can't live on 90% of what you make.

    Kris (TMF copyeditor)

  • Report this Comment On November 30, 2013, at 5:20 PM, ceh4702 wrote:

    So how does a pre-tax saving plan work out. The premise is that you save some money and that money is pre-tax so it reduces your tax bill. You eventually have to pay tax but only when you withdraw it. So it reduces your yearly Income and then you pay no tax on it till you withdraw it.

  • Report this Comment On May 15, 2014, at 7:35 PM, mzmadness wrote:

    Me, my husband, and our family have a total of $1150 a month in expenses (would be $1500 but we rent out a room to a friend) we put $2350, what's left of our incomes, away a month. We have an ok apartment and we go out sometimes. We aren't suffocating in a tiny place or living in the ghetto and we are happy. At this rate, minus savings account bank interest we're accumulating, we will have $28,200 within 12 months; plus the 11k we have now. Saving is not only possible it's easy. We searched city after city till we found one that would let us fully pursue our growing careers while not sending us into debt or overdrive with the cost of living. Then discipline with what you purchase, coupons, etc it really is easy once you're used to sticking to your budget. Did I mention we're under 25 and still in school full time? Ya it's that easy.

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