Retirement Rules: Which to Follow, Which to Rethink

When investing for retirement, you’re likely to hear well-meaning guidance from family, friends, and others. As you weigh the potential benefits of any commonly cited investment rules, consider that most are designed for the average situation, which means they may be wrong as often as they’re right. Although such guidance is usually based on sound principles and may serve as a good starting point, think carefully about your personal situation before taking any tips at face value.

Here are five common “investment rules” and related considerations. 

Your stock allocation should equal 100 (or 120) minus your age 

A widely accepted retirement savings principle states that the younger you are, the more money you should invest in stocks. Though past performance is no guarantee of future results, stocks have typically provided higher long-term returns than other commonly held securities. As you age, you have less time to recover from market downturns. For that reason, this approach suggests shifting some of your more volatile, growth-oriented investments into fixed-income securities like bonds as you near and enter retirement. 

Some investors use a simple rule of thumb to set their stock allocation: subtract your age from 100 (or 120 in some versions). For example, at age 40, this approach suggests investing 60% to 80% of your portfolio in stocks. A more thorough approach considers other key factors, including your risk tolerance, long-term goals, family situation, existing assets, access to a pension or other income sources, and your overall health. In some cases, maintaining or increasing stock exposure throughout retirement may better serve your needs, but doing so increases exposure to market volatility and potential losses, particularly during market downturns. 

You will need 70% to 100% of your pre-retirement income

You’ve probably heard this many times before: you should calculate a goal based on replacing at least 70% of your pre-retirement income each year during retirement. But this calculation doesn’t take into consideration your individual needs, expectations, and goals. 

Instead of basing your estimate on a percentage of your current income, focus on your actual expenses today, recognizing that future expenses – particularly healthcare and long-term care – can be difficult to predict, and consider whether they’ll stay the same, grow, shrink, or disappear entirely by the time you retire. 

While some expenses may disappear, others, such as healthcare, travel, and hobbies, may rise. You may also want to hire help for yard care, snow removal, or other home maintenance that you previously did yourself. 

Focusing on your projected expenses can help you build a more realistic picture of your annual income needs and identify a target accumulation amount.

Save 10%, 12%, or 15% of your current income for retirement 

While the advice to contribute a certain percentage of your income to your retirement savings plan probably falls into the “smart rule” camp, particularly if the target rate is 10% or higher, it may not be appropriate for everyone. 

For example, if you start saving for retirement in your 40s or 50s, you may need to target the absolute maximum allowable amount (including catch-up contributions if you’re age 50 or older) to make up for lost time. On the other hand, if you are in your 20s and facing a mountain of school loans, you may want to start at a lower percentage of pay, about 5% or 6%, and increase your contribution amount gradually as your income rises and your overall debt level decreases. Many employer-based plans offer auto-escalation features that increase your contribution amount automatically over time. 

Contribute enough to receive the full employer match 

In many cases, regardless of your age or financial situation, this tip has benefits worth considering. If your work-based plan offers a match, contribute at least enough to receive the full amount. This is money that your employer contributes for your future. Don’t neglect this potential opportunity to help build your retirement savings. (Note: Employer contributions are often subject to a vesting schedule, which means you earn rights to the contributions and any earnings on them over time.) 

A “smart” withdrawal rate is 4% 

If you’re approaching retirement, an important consideration is how much you can withdraw from your account each year. The sustainability of your savings depends not only on your asset allocation and investment choices, but also on how quickly you draw down the account(s). Basically, you want to withdraw at least enough to provide the income you need, but not so much that you run out of money quickly. The percentage you withdraw annually from your savings and investments is called your withdrawal rate. The maximum percentage you can withdraw each year without depleting your savings is known as your “sustainable withdrawal rate.” 

A common belief states that a 4% withdrawal rate during retirement (adjusted for inflation) will be sustainable. However, its effectiveness depends on factors such as market conditions, portfolio composition, inflation, and longevity. Consequently, this method has its critics, and financial professionals use other strategies and models to calculate sustainable withdrawal rates. Some alternatives include: 

• withdrawing a lower or higher fixed percentage each year; 

• using a rate based on your investment performance each year; or 

• choosing a rate based on age. 

Factors to consider include the value of your savings, the amount of income you need, your life expectancy, the expected rate of return on your investments, inflation, and taxes. 

Determine which Rules Are right for you 

When it comes to investing, following rules of thumb may be a good place to start, but think carefully about how they might apply to your personal needs, goals, and circumstances before making any decisions.  

This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant. Please consult your investment professional regarding your unique situation.