Accumulators: Is Your Retirement Plan on Track?

A version of this article previously ran on Jan. 25, 2021.

Are you saving enough?

It might seem like the most basic of investing questions, but for many people, the "right" answer is elusive. Even people who are comfortable tackling sophisticated financial tasks like determining their asset allocations and conducting due diligence on individual stocks and funds may hem and haw when it comes to assessing the viability of their savings rates and, in turn, the soundness of their plans.

It's not hard to see why. The right level of savings depends on a huge range of factors, many of them highly dependent on each individual and others simply unknowable. Unless retirement is close at hand, few of us know how much we'll want or need to spend in retirement. Nor do we know how much of a helping hand market returns will provide over our holding periods, both in the years leading up to retirement and during it. And then there's the mother of unknowables: the duration of our retirement years, which requires us to forecast our own life expectancy.

Rules of Thumb Are Just That

For people who are in retirement savings mode, there's no shortage of rules of thumb available to gauge savings rates and, by extension, the soundness of an investment plan. Investors may have heard that they should be saving 10%, 15%, or 20% of their salaries.

But those rules of thumb can be dramatically affected by the assumptions underlying them. For example, a study from the Center for Retirement Research at Boston College suggests that individuals earning an average wage who save 15% of their annual earnings from age 35 to 65 will be able to retire at age 65 with financial security, assuming a 4% real return on investments. But if they're able to delay retirement (and portfolio withdrawals) until age 70, their anticipated savings rate drops to just 6%, according to the study.

In attempting to help investors address the "how much is enough?" question, Fidelity Investments has created retirement-savings targets by age. Its research suggests that investors could reasonably target a retirement nest egg amounting to 10 times their ending salaries at age 67. By age 35, investors should aim to have set aside a retirement kitty equal to 2 times their current salaries, with retirement assets escalating to 4 times current salary by age 45 and 7 times salary by 55. My colleague Amy Arnottt wrote that the benchmarks may not be right in every situation, especially for people with irregular earnings trajectories, but they're a starting point.

Collect Data, Calculate, and Customize

Those guideposts, while helpful, are blunt instruments: Asset allocation, income-replacement rate assumptions, and the expected length of retirement all have an impact on whether a pre-retiree's savings rate is adequate. For that reason, it's valuable to assess your retirement preparedness using your own data.

Here are the key steps to take.

Step 1: Gather your inputs. The first step is to pull together data about your current plan, including current investments earmarked for retirement; annual retirement savings; expected retirement date; and other expected income sources in retirement.

Step 2: Find your current asset allocation. Because the asset allocation of your portfolio will be a key determinant of what sort of return you earn over your time horizon, it's helpful to start with a clear view of your current stock/bond/cash mix. (Don't include any assets you have earmarked for nonretirement goals, such as college savings.) Plugging your holdings into Morningstar's Instant X-Ray is an easy way to gauge your portfolio's current asset allocation.

Step 3: Plug it all into a holistic calculator. Because savings targets will be so sensitive to individual-specific inputs, online calculators that allow investors to adjust these inputs are the best way for investors to determine the adequacy of their savings rates. Most of the major financial-services providers offer some type of tool to gauge retirement preparedness, including Vanguard's Retirement Income Calculator, T. Rowe Price's Retirement Income Calculator, and Charles Schwab's Retirement Calculator. The Bogleheads site provides a helpful overview--with links--to both free and paid retirement-planning calculators.

Because all of these calculators are a bit different--and because retirement readiness is such an important issue--be prepared to sample a range of calculators rather than settling on just one. Also, focus on the most holistic tools you can find; for example, the T. Rowe Price tool incorporates Social Security income and also takes into account the asset allocations and tax treatment of various asset pools in the investor's portfolio.

Step 4: Customize and course-correct. As you work with these calculators, it's also valuable to tinker with the inputs--rather than relying on any preset inputs--so that the calculator is factoring in your own situation. If it looks like you'll fall short based on your starting assumptions, you can make adjustments to help improve your probability of success.

Among the variables you will be able to customize--and that have a big effect on the success or failure of a retirement plan--are the following.

Income-Replacement Rate: Generally speaking, higher-income workers and heavy savers will need to replace a lower percentage of their working incomes when they eventually retire than will lower-income workers with lower savings rates.

Anticipated Retirement Age: Being willing to work longer, assuming you are able to do so, can deliver a benevolent three-fer; the person who delays retirement can continue to accumulate savings, while also increasing Social Security benefits and decreasing portfolio withdrawals. All three steps can have a powerful effect on a portfolio's staying power.

Life Expectancy: Predicting your own life expectancy is the trickiest business of all, but it's worth thinking through, factoring in variables like personal health and your family's history of longevity.

Expected Rate of Return: Be conservative here, especially if your portfolio is bond-heavy, and customize your expected return based on your asset mix. In my recent roundup of forecasts from major investment providers, 10-year U.S. equity return forecasts ranged from 2% to 6%, whereas high-quality fixed-income returns converged in the 2% range. Non-U.S. equity return forecasts were higher across the board. Bear in mind that these forecasts typically cover the next 10 years or even fewer; most retirement accumulation periods are much longer than that. To calculate your portfolio's expected return based on its asset allocation, simply adjust your anticipated return for an asset class based on its weighting in your portfolio. For example, if you have a 60% equity/40% bond portfolio and you expect 6% (nominally) from stocks and 2% from bonds, your portfolio's expected return is 4.4%. (The 6% equity return times its 0.6 weighting (3.6%) and the 2% bond return times its 0.4 weighting (0.8%).)

Savings Rate: This will be a bigger swing factor if you're earlier in your savings career and have more time to benefit from compounding. The Center for Retirement Research study about savings percentages demonstrates that older individuals looking to make up for a savings shortfall will need to ratchet up their savings significantly to get their plans on track; they will improve the viability of their plans more if they're willing to delay retirement and/or reduce their planned in-retirement spending per year.