A while back I posted about the concept of a safe withdrawal rate, the percentage which you can withdraw from your portfolio each year in retirement, adjusted for inflation, at which you shouldn’t run out of money before dying. Wade Pfau, a finance professor, published a paper this year in which he discussed the concept of a safe savings rate. A reader recently posted a comment asking how much he needed to save each year in the accumulation stage of his life. Although the answer I am tempted to give is “as much as you can” (which is probably accurate from a behavioral perspective), from an academic and theoretical perspective, the answer is that it depends. But Professor Pfau’s paper nails it down about as well as one can.

The real meat of the paper is Table 1, which I’ve reproduced here.

Let’s look at the two extremes to get an idea of what the table is actually saying.  First, if you only work and save for 20 years, then want to live in retirement for 40 years on 70% of the salary you were making when you were working, and you’re only willing to use a portfolio that is 40% stocks, then you need to save 66% of your income each year.  On the other hand, if you’re willing to work for 40 years, have a retirement of 20 years, live off 50% of your final salary, and use an 80/20 portfolio, then you only need to save 6.3% of your salary.

There’s obviously a big difference between 6% and 66%.  Most of us are probably somewhere in the middle.  A more reasonable assumption is 30 years working, 30 years retired, live off 50% of final salary in retirement (remember you no longer have to pay as much in taxes or save for retirement and you’ll likely get something from social security) and use a more standard 60/40 portfolio.  This reveals you need a savings rate of 17%.  Now that’s off your gross income.  This is the basis for my usual recommendation to save 15-20% of your income.  10% probably isn’t enough.  25-30% is for those who want to retire early. If you want to retire really early (before 50), you’d better be pretty darn thrifty both before and after retirement.  Even with only living off 50% of your salary (remember social security won’t kick in for a decade or more after you retire) and investing aggressively, you’ll still need to save over 1/3 of your income during your working years.