The question in the title is one I’m asked quite frequently. Unfortunately, I never feel that I’m able to give a satisfactory answer. Easy-to-follow instructions like, “invest 10% of your income” are popular, but I think they’re rather problematic.
The amount you should invest per year depends significantly on your plans and circumstances. To get even a ballpark figure, there’s a whole list of questions that need to be answered.
How Much Will You Need (per year) in Retirement?
- How will your retirement spending compare to your pre-retirement spending?
- Will you have a pension?
- Will there be a stage of semi-retirement during which you’ll have income from a job or business?
The more you expect to spend in retirement, and the less of that spending that will be satisfied via wages or a pension, the more you need to save now.
How Much Will You Need (in total) to Retire?
- At what age do you expect to retire?
- How much of your portfolio are you willing to annuitize?
- Is it important to you to leave money to your heirs?
The longer your expected retirement, the more money you need saved, and the fewer working years you have to reach that level of savings–meaning you need to save significantly more per year.
Working in the other direction, the less you care about leaving money to heirs, and the more of your portfolio you’re willing to annuitize, the less money you’ll need saved before you can retire (and, therefore, the less you have to save each year).
How Many Years Do You Have to Save?
- When did you start investing?
- Did you (or do you expect to) take any years off to have/care for children?
For example: Investor A gets a full-time job at age 22 and works straight through to age 65. Investor B gets a full-time job at age 25, doesn’t start saving until age 28, takes 6 years off from 30 to 35 to have/care for children, then works from 37-60, at which point he/she retires.
Investor A has 43 years of saving. Investor B has 26 years of saving. In order to finance the same level of retirement spending, Investor B will have to save significantly more per year than Investor A.
A Better Approach
Rules of thumb that ignore all of the above person-specific circumstances will, by definition, lead some investors to dramatically under-save and others to dramatically over-save.
Instead, I’d suggest working your way one-by-one through the following questions:
- How much do I expect to spend each year in retirement?
- How much of that spending will have to be financed by savings (rather than Social Security, pension, part-time job, etc.)?
- How much (total) savings will I need in order to finance that level of spending?
- Given how many years I expect to be saving, how much must I save per year to reach that level of savings?