You shouldn't (and can't) save a fixed percentage of your income every year of your life...

It's common to read that people should be putting away a certain portion of their income for retirement. The figure I see most often is 15%. Usually, there's a comment that the sooner that people start saving the better.

Some authors go as far as providing a formula for how much you "should" have saved by a certain age. For example, in Stop Acting Rich: ... and Start Living Like a Real Millionaire, Thomas J. Stanley (better known as co-author of The Millionaire Next Door) discusses his "Wealth Equation":

"Simply stated, your net worth [augmented] should equal 10 percent of your age times your annual realised household income (0.10 x age x income = expected net worth)."

This all sounds like sound advice. And if you want some confidence about your retirement, it's true that over the course of your life you need to save a substantial portion of your income. 

The key point, however, is that the savings need to occur over the course of your life

Stanley's equation is absurd for many people in my situation. My wife and I have a decent household income. If we apply the equation to our situation, our net worth should be many, many times more than our actual net worth. Why is that? Because we're still relatively young, and have spent a large portion of our lives to date studying rather than earning, and a significant amount of our "savings" have been in the form of student loan repayments.

Add to this that of our "productive" years, we've also had to live on a single income while we've raised very young children. Although we are fortunate that it hasn't been the case for us, I don't think it's unrealistic for many people to go backwards financially during the first years of their children's lives. 

So the equation is absurd, but also the broad statement that we should have been saving 15% of our income every year of our working lives. There are times in your life when it is realistic to make savings. But there are times in your life when it's not so realistic.

The idea of saving for retirement is that you are smoothing the consumption of your lifetime income over the course of your entire life. The underlying idea applies not only to retirement, but to other periods of your life. Savings and consumption can, do, and should, go up and down over the course of your life. Examples include times when you are studying, perhaps when you are early in your career and aren't earning a significant income, and when you have dependant children.

I agree with the general comment that over the course of your life you should save a substantial portion of your income. My intuition is that 15% should be a minimum (so if you're in Australia, your compulsory superannuation contributions on their own are probably inadequate), but this will depend on your circumstances and your values and beliefs. 

There are times in your life when that level of savings is impossible, and counter-productive. There is a lot of value in terms of playing "defence" and trying to limit expenditure during those times when savings aren't possible. And if you're studying and incurring debt it's best to be mindful that you'll need to be able to repay the debt. But that's really the best we can do.

The corollary of this is that if we need to save 15% or more on average over the course of our working lives, it means that we need to be saving even more during those periods when we can genuinely afford to save.

 

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Sonnie Bailey

Sonnie is the founder and principal of Fairhaven Wealth.

Before founding Fairhaven Wealth, Sonnie worked in the legal and financial services industries for over a decade.

Sonnie first became involved with financial advice as a specialist financial services lawyer. For many years, he was an “adviser of advisers”, reviewing thousands of advice files prepared by hundreds of financial advisers, and providing feedback in relation to the quality and appropriateness of advice; industry best practice; risk management; and regulatory compliance. He has published work in industry publications and spoken at various financial advice conferences.

Sonnie has also worked with banks, investment management firms, insurers, and derivatives providers.

Sonnie has worked as a private client lawyer, focusing on succession, estate planning and trusts. He ran his own legal firm in Australia before relocating to New Zealand. He has also acted in independent trustee and company director positions.

Sonnie is passionate about helping people achieve their goals and manage the risks to which they are exposed.

He has written extensively on his blog, New Zealand Wealth and Risk, which can be found at www.wealthandrisk.nz.

Sonnie is married to his wonderful wife Chrissy, and has two young children, Ben and Anna.