The World Needs More Ninjas

Previously, I tried to convince you of the necessity and value of saving. In this post, I want to address how much you should try to save for retirement. These are just guidelines based on what I’ve read in the past. However, even if you can’t reach these guidelines, please don’t let it stop you from saving something out of each paycheck. Even if you can just put $25 per paycheck in a retirement savings account, that’s much more beneficial to you than saving zero.

So, how much of each paycheck should you aim to put into retirement savings? Everything that I’ve read recommends from 10-20% of your before-tax pay. Of course, if you can save more while still achieving what you consider an adequate standard of living (e.g., being able buying a house or car, save for college, vacations) then that’s fine. But the 20% upper limit kind of gives you a ceiling that you can build towards.

Note that this percentage comes off you before-tax pay, not your take-home pay. So, if you get $1000 per paycheck, but only $800 after taxes, social security, health care, etc. are taken out, then your goal should be to put at least $100 of your $800 into retirement savings. Ideally, you would put $200, or 25% of your take-home pay, into retirement savings. This is quite a bit and is probably infeasible for most people, but it gives you something to aim towards (e.g., when your income increases due to a raise or paying off a loan).

Note that there are two important reasons to save a percentage of your before-tax pay for retirement. Obviously, you benefit because that money is invested over a long time period and should grow significantly due to compound interest. But the second, perhaps more subtle, reason is that you get used to living on a fraction of your pay.

This latter reason has a couple of important ramifications. Let’s say you save 15% of your before-tax pay for retirement. This means that you are able to live on 85% of your salary. The first benefit is that you’ll need less income when you retire and start to to draw money from you savings. If your pay was $50K per year, then you have accustomed yourself to only living on $42,500 per year. Thus, when you start drawing from your retirement savings, you’ll only need to provide yourself with $42,500 per year instead of $50K (ignore inflation in this example and assume that all numbers are adjusted to real values). That $7,500 difference per year will prove to be extremely significant if you’re going to be drawing from your savings for 20-30 years. In addition to preserving your principle, you also increase the amount of compound interest you earn during that period.

A second ramification of living on less than 100% of your salary is that you have an automatic safety net. Although you should try to avoid reducing your retirement savings like the plague, it does give you a fallback in worst case circumstances when a significant unexpected expense pops up. If you’re saving 15% of your salary, that’s money you’re not using in your everyday life. If, say, a major medical expense arises, then you can use the 15% you would normally be saving towards retirement to pay and still not affect your regular lifestyle.

In the future, I’ll discuss budgeting in general more, but for now I wanted to provide guidelines for retirement savings since that’s the first thing for which you should budget. Again, even if you can’t save 10% of your salary towards retirement, starting with something is much better than nothing. So, with this and the previous post, I have focused on the value of investing and the amount to invest. My next posts will focus on how to invest your retirement savings, both in terms of what types of accounts to use and asset allocation.

Here’s an article that might be of interest to you: The NY Times’ Financial Advice for New Graduates.

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