A popular retirement savings strategy looks at your age and tells you how many multiples of your income you should have saved. But how much you need for retirement is a very unique number to you.
While these rules of thumb can serve as a guide for what types of goals you should set, I plan as much as possible for my individual circumstances and take these generic processes with a grain of salt for these three reasons.
1. They don't consider my time horizon
If I plan on retiring at age 65, the amount of money that I need for retirement could be very different than if I retire at age 70. Depending on my life expectancy and my expenses, the extra five years that I'm not drawing from my retirement assets could mean I need a lot less.
The extra five years also give me more time for accumulating money for when I retire. If I don't start saving until I am 40 and plan on retiring at 70, I have a 30-year time horizon. If I save $10,000 annually at a 7% average rate of return, my accounts could grow to $1.01 million. But if I only have 25 years, my accounts could only grow to $677,000.
If you can start when you are young, you have more years in which you can save. This is especially helpful if you can't contribute very much every year. But when you are older, you could be a higher wage earner and meet your goal in a shorter time span and higher dollar amounts saved each year. That's why, when setting your goal, thinking about when you plan on retiring and how much money you could have by then should matter more than your current savings at your current age.
2. They don't factor in my expenses in retirement
How much I spend in retirement could play a bigger role in how much I need than how much I accumulate. And if I only look at the amount I save, I could overestimate the number of years my money will last. For example, if I save a million dollars but my expenses are $80,000, I will end up taking 8% of my portfolio value. This could potentially put me in a worse situation than if I only save $500,000 but my expenses are $20,000 and my withdrawal rate is 4%.
When you determine how much you save for retirement, you should take stock of your future income sources. How much will you receive annually in payments like Social Security or a pension? And how much do you expect your expenses will be? After you subtract your expenses from your income, do you end up with more money than you need, just enough, or a shortfall? From there, how much you save should be enough to supplement this gap rather than a factor of your age.
3. They don't account for rates of return
My rate of return matters because it will determine how much my accounts grow. And even if I've done a great job saving, I could still end up short if my accounts don't get enough stock market appreciation. I also could get away with saving less potentially if I can earn more each year on average. If I can save $10,000 each year but earn 9% instead of 7%, my accounts could grow to $923,000 if I have 25 years and $1.49 million if I have 30.
The rate of return that you receive should be based on more than just how much your accounts can grow and should consistently evaluate your risk tolerances. Not having enough stocks could cause your long-term growth to suffer. But being too aggressive in the years leading up to retirement could put you in a position where you could experience significant losses when you need your money most. Taking a simple quiz that evaluates things like how you've reacted to volatility in the past can help you find the best asset allocation model.
It takes a little extra work, but when I plan for retirement, I customize it as much as possible. And if you want the most accurate forecast of what you will need, you should too. Most importantly, you should not let numbers of how much you could need in retirement scare you if you're not quite there. There are things that you can potentially control, like working longer, changing your investment mix, or cutting your expenses that can help you get to the place that you want.