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How to Calibrate Your Target Savings Rate

Rules of thumb are better than nothing, but smart investors customize their own savings targets.

An illustrative image of Christine Benz, director of personal finance and retirement planning for Morningstar, and illustrative representations of the Morningstar Medalist Rating and Morningstar Star Rating.

A while ago, I spoke with a friend who was worried about his retirement portfolio. Was he too conservatively positioned, he wondered? Would adding more small-cap stocks help him bridge the shortfall in his retirement kitty?

After taking a look, I didn’t find dramatic problems at the portfolio level, though I agreed he could add a dash more small-cap exposure by supplanting his S&P 500 index fund with a total stock market index tracker.

The bigger problem was that he simply wasn’t saving enough of his salary. While he was looking to his investments to do all the heavy lifting on the road to his retirement, what he really needed to do was to take a close look at his budget in an effort to bump up his savings rate and reduce spending.

My friend’s predicament is a common one. While many people have heard about rules of thumb for savings rates—for example, that you should save 10% of your salary—they haven’t taken the time to calibrate their savings rates to factor in their own situations: their incomes, how much they’ve managed to save so far, their proximity to reaching retirement (or any other financial goal), and the return they can expect to earn on their investments. A 10% savings rate is better than nothing, but it’s not going to be enough in many cases.

By using your own financial goals to formulate concrete savings targets—and periodically revisiting them to take into account changes in income, expected market returns, or proximity to the goal date—you have a better shot at reaching your financial goals than if you fall back on rules of thumb. Rather than setting a savings rate in a vacuum, start with the amount that you’ll need to amass for a given goal, then work your way backward to determine how much you’ll need to save on an ongoing basis. Here are the key steps to take.

Step 1: Identify and prioritize goals.

The first step in the process is to take a close look at what financial goals you’d like to achieve, factoring in your wishes as well as what makes sense from a financial/return on investment perspective. Even if you haven’t spent much time on goal setting, you can do a quick-and-dirty version right now. List your financial goals—short-, intermediate-, and long-term—and rank from highest to lowest priority. Don’t forget to include debt paydown as a goal, especially if you have high-interest-rate debt on your household balance sheet; paying down that debt should be right up near the top of your list. Building an emergency fund should also be toward the top of the priority pyramid for all investors.

Step 2: Quantify goals.

If a goal is very close at hand—for example, you’d like to amass $10,000 for a condo down payment by year-end—you don’t need to get bogged down in thinking about how inflation will affect your goal amount.

But if your goal is further out in the future, it's worth thinking through and quantifying how your goal amount could increase over your savings horizon. You can use an inflation calculator like this one to determine what a goal will cost in the future.

It’s a heavier lift to figure out how much you’ll need for very long-term goals with multiyear durations, especially retirement. Because there are so many moving parts to determining cash flow needs for a retirement that could last 25 or 30 years or even longer, I recommend using a comprehensive retirement calculator. The best such calculators take into account your proximity to retirement; your expected years in retirement; other sources of income you’ll be able to rely on in retirement, such as Social Security; and the complexion of your investment portfolio, among other factors. You’ll be able to create an estimate of how much money you’ll need for retirement based on your current income and spending.

Step 3: Back into a savings target that factors in savings duration, goal duration, and return expectations.

Armed with a list of your goals and a rough cost for each, you can then back into the amount you should be saving to achieve them. For straightforward, nonretirement savings goals, you can use a basic savings calculator and experiment with the variables to determine how much you’ll need to save. For example, let’s say you’ve determined you need an emergency fund that amounts to $24,000. You’ve already saved $10,000 toward this target, and you’d like to have the full emergency fund pulled together by this time next year. Assuming a 5% rate of return on your money—what some savings accounts offer today—you’ll need to save $1,100 a month for the next year to hit your goal amount. You can adjust the variables to arrive at a savings amount and duration that’s reasonable for you.

Use a more sophisticated calculator to model out your savings target for retirement; the best such calculators, such as T. Rowe Price's Retirement Income Calculator, factor in nonportfolio income sources like Social Security, the asset allocation and projected return of your investment portfolio, and the tax treatment of your assets upon withdrawal.

If you’ve arrived at savings targets for some of your key goals and find that the savings amounts in total are unrealistic and/or downright impossible, you can refer back to your goal prioritization (Step 1). Tweaking your budget is also an option. Be cautious before nudging up your expected rate of return to help make the savings load more manageable: While savings yields are higher, equity-market returns can be mercurial. Assuming a 4%-5% return for a balanced portfolio is reasonable for the next decade; if you have a much longer time horizon, you can reasonably assume a somewhat higher rate of return.

This is an updated version of an article that originally published on July 13, 2019.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Author

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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