In an earlier post we wrote about the most underappreciated number in finance - your retirement savings rate (RSR). Most people will need a 15% RSR to become financially independent by their 60's.
If you're like most people, you're only vaguely aware of your RSR, despite its extreme importance. Furthermore, most people aren't saving anything near 15% for retirement and, after looking at their finances, they probably think it's an impossible figure to reach.
How to measure your RSR
Every worker should diligently measure and track their RSR annually. Start with your total income for the year. (Total income is the salary and other earned income that you make before taxes.) Someone with a $100,000 salary and no other income would use $100,000 as the denominator. Then add together the dollar amounts of:
- your IRA contribution (Roth IRAs are generally preferable if you are eligible.)
- saving in your company sponsored retirement plan (401k, 403b, etc.)
- the employer match (this is free money, not to be missed)
- your savings in a personal account dedicated to your retirement
Take the total and divide by your income for the year; the result is your RSR. Remember, you'll probably also need to save for other things: cars, a home, education, weddings, etc., so your total savings rate should be higher - perhaps in excess of 20% of income.
Automate. Automate. Automate. The best way to reach your savings rate target is to use the automatic withdrawals feature from your paycheck, or have automatic deposits set from your bank on payday. Build your retirement savings first, then live on the rest.
Why a low RSR is scary
First, a low RSR means your total savings probably won't be sufficient by the time you plan to retire.
The second reason Is less obvious, but maybe even more important: a low RSR implies that you have a high spend rate. Yikes! You don't want a high spend rate when the paychecks stop. Optimally you'll be mortgage free, have your cars paid off, and have a relatively low level of ongoing financial commitments.
Consider the Able family. They make $100,000 per year and have a 15% RSR. That means the other 85% is used for living, taxes, and giving. The Baker family, on the other hand, makes the same $100,000, but only has a 5% RSR. They are spending $10,000 more per year than the Able family
and they have a smaller retirement savings balance. Spending more from a lower saving balance means the retirement account runs dry that much faster.
How to build a satisfactory retirement savings If you can't get to 15% right now:
Spend only 50%
of your raises
As the chart below suggests, wage growth is usually substantial in our early career and tapers off, and even declines, around the age of 50.
Average Earnings - U.S. Citizens
Master Earnings File of the U.S. Social Security Administration. Compiled by Guvenen: University of Minnesota, Federal Reserve Bank of Minneapolis
If you're young, you should commit to saving at least 50% of your salary increases. Then watch the magic at work! This does three things well:
- Builds your saving without crimping your life style.
- Accelerates your saving and RSR throughout your career (sometimes with a RSR greater than 30%). When this happens, you'll be in "high margin" financial zone, just about were everyone wants to be.
- Moderates your spending which gives you a slower "burn" when the salary stops.
Additionally, this plays into classic human behavior: We'll diet later, we'll save later. This
is the the saving later option. If you save 50% of your pay raise you'll still see a bump in your lifestyle as you spend the other 50%. It will feel good!
Stay intentional and stay disciplined. When the pay raise happens, automate 50% of your raise into your retirement savings. Spend or give away the rest with joy knowing that you are on a terrific track to build your RSR while also living a controlled, but growing lifestyle.