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3 Retirement Rules of Thumb That Really Work

Plus: how to tailor them to your circumstances


(This article previously appeared on RealDealRetirement.com.)

We’re always told not to rely on rules of thumb for retirement planning. They’re too general, have too many exceptions and produce less-than-optimal results. All of which is true.

And yet, rules of thumb can also be helpful, especially if the alternative is not planning at all or getting too fancy and botching things up.

The Ideal World Vs. Reality

In an ideal world, we would all take a long hard look at our finances, rigorously project our estimated lifetime earnings so we know precisely how much to save to maintain our standard of living in retirement and figure out the mix of stocks and bonds that would provide the returns to grow our savings adequately without exceeding our tolerance for risk. And, of course, we’d faithfully monitor our progress and make occasional adjustments along the way.

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But we don’t live in an ideal world. We live in a world where a volatile and unpredictable market makes forecasting difficult and where retirement planning competes for our time, attention and financial resources with many other obligations. As a result, many people simply aren’t going to devote the time and attention to retirement planning that it deserves.

If you are one of them, here are three rules of thumb that, while far from perfect, can at least give you a shot at a secure retirement. And on the off chance you find yourself up for ways to improve your retirement prospects once you’ve got your planning underway, I’m also offering a way to improve on each rule of thumb.

3 Retirement Rules of Thumb

1. Save 15 percent a year. It’s impossible to know exactly how much you must sock away in retirement accounts each year to have a reasonable chance of maintaining your standard of living retirement. But 15 percent of salary a year is a pretty decent target. 

Indeed, a recent Boston College Center for Retirement Research report cited 15 percent of income as the amount the typical household should save. And in his book Your Money Ratios: 8 Simple Tools For Financial Security, Northstar Investment Advisors’ Charles Farrell recommends 15 percent annually, at least initially.

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That 15 percent figure, by the way, includes any employer matching funds you may receive by contributing to a 401(k) or similar retirement account. So you may not have to get to 15 percent on your own.

How to improve on this rule: One problem with this benchmark is that if you got a late start on saving, even 15 percent a year may leave you with a smaller nest egg than you’ll need. Also, the percentage of income you need to save can depend on the lifestyle you want in retirement and how much you earn during your career. (High earners typically have to save more than lower earners because Social Security will replace a smaller percentage of their pre-retirement income.)

You can get a more accurate fix on how much to save by using a tool like the Will You Have Enough to Retire? calculator in my RealDealRetirement Toolbox. If you do this periodically and, if necessary, adjust the amount you save, you should be able to stay on track toward a comfortable retirement.

2. Create an investment portfolio based on your age. The rule of thumb to figure out what percentage of your retirement savings should be in stocks: subtract your age from 100. So if you’re 50, you would invest 50 percent in equities, and when you’re 75, that percentage would decline to 25 percent. The rest goes into bonds.

The premise behind this rule is that the younger you are, the more your focus should be on earning high long-term returns, which the stock market has historically delivered over the long term. As you near and enter retirement and begin looking to your portfolio to provide regular income, your focus shifts more toward protecting your savings. So you’ll likely want a more conservative investment portfolio that will be more stable.

(MORE: Money Rules of Thumb to Follow and Avoid)

For example, while a portfolio of 75 percent stocks and 25 percent bonds would have declined 26.5 percent in the financial crisis year of 2008 when stocks got hammered, a more conservative mix of 25 percent stocks and 75 percent bonds would have lost only 5.4 percent.

How to improve on this rule: The major shortcoming of this rule is that not everyone of the same age has the same tolerance for risk. Some 45-year-olds might be more cautious than others and prefer a less stock-intensive portfolio. And some 75-year-olds might be willing to accept a higher level of volatility than others.

Also, in addition to risk, you also need to consider potential return. While you may find a more conservative stocks/bonds mix more emotionally appealing, it might not provide the returns you’ll need to build an adequate nest egg. To find a mix that provides a reasonable balance between risk and return, fill out this Investor Questionnaire.

3. For retirement withdrawals, start with the 4 percent rule. Pulling enough money from your nest egg to give you sufficient income while not withdrawing so much that you’ll deplete your savings too soon is one of the major challenges retirees face. And over the years, advisers and academics have come up with a variety of ways to address this issue. But if you’re looking for a very simple method, start with what’s known as the 4 percent rule.

Here’s how it works: The first year of retirement, you withdraw 4 percent of your total retirement savings. Then you  increase that dollar amount by the inflation rate annually to maintain purchasing power. So, if you have $500,000 in all your retirement accounts, you’d withdraw $20,000 the first year of retirement. If inflation is running at 2 percent, you’d increase that $20,000 to $20,400 the next year, $20,800 the next, and so on. By following this rule, you should have a relatively high level of assurance — generally an 80 percent or so chance — that your savings will last 30 or more years.

How to improve on this rule: This rule of thumb is perhaps the most controversial of the three, for good reason.

For one thing, the premise is that you want your money to last 30 or more years. I think that’s a reasonable assumption for many people retiring at 65. But if you’re retiring at 70 or later, you may not need your money to last 30 years and you can start with a more generous initial draw.

Also, even though the chances of your money running out following the 4 percent rule are relatively low, there’s no guarantee your dough will last. In fact, you could deplete your nest egg much sooner than 30 years, especially if your investments incur losses early in retirement.

And there’s another risk: If your investments do well, sticking to the rule could leave you sitting on a big pile of savings late in life. That might not sound like a risk, but it could mean that you unnecessarily stinted early in retirement when you could have spent more freely and enjoyed yourself more.

So while the 4 percent rule can be a reasonable starting point, don’t follow it blindly. You’ll want to be flexible and maintain the ability to shift your spending up or down based on your needs, your age and how much savings you have left.

You can do that by going each year to a good online retirement income calculator, and plugging in the size of your nest egg, your planned withdrawal and the number of years you want your savings to support you. The calculator will then estimate the probability that your nest egg will last. Based on that estimate, you can then increase or decrease your planned withdrawal.

Bottom line: A rule of thumb can’t address all the complexities of real life. But following a good one is better than just winging it and ideally may lead you do more nuanced planning down the road.

Walter Updegrave
By Walter Updegrave
Walter Updegrave is the editor of RealDealRetirement.com, a site that offers easy-to-understand-and-follow advice on retirement and investing. Walter previously wrote the Ask the Expert column for CNNMoney.com and MONEY Magazine and has published four books on personal finance. If you have a question on retirement or investing that you would like Walter to answer online, send it to Ask Real Deal Retirement. You can follow Walter on Twitter @RealDealRetire and reach him at [email protected].@realdealretire

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