Factors that impact a savings plan are so varied that no single strategy -- or even a combination of plans -- will meet the goals of most people. Fortunately, there are rules of thumb and general guidelines that exist, taking into account variables such as age, years to retirement, savings goals, income levels and lifestyles. Online calculators also are available that allow you to input personal data, thus yielding an approximation of your savings needs.
One of the first steps in developing a savings strategy is deciding why you want to save. Most people who are developing a long-term savings plan have retirement in mind, specifically trying to ensure a specific lifestyle. Others may have a more short-term savings plan in mind for occasions like purchasing a new house or a child's education. However, some general strategies can be applied to most savings goals.
Retirement Savings Groundwork
Most people have read -- or seen on television -- advice and tips on saving for retirement. This advice typically is preceded by a series of questions that investors must ask themselves, and answer, before a plan can be developed. The most fundamental factor is the number of years until a person's retirement. Of course, age, health, income level, current savings, marital status, inflation rates and other financial obligations all play roles, but they're all related to the crucial issue of how long someone has before they'd like to retire. Online savings and retirement calculators input all this data to help people compute how much income --- both as a percentage of income and in dollar figures --- they need to save to reach their goals.
There are dozens of formulas that have been developed to aid in creating a retirement savings plan, most adhering to basic principals and assumptions of savings rates, retirement ages, life expectancy, interest rates, investment return rates and other criteria. For example, the "Journal of Financial Planning," in a 2007 report, developed detailed charts for people from ages 25 to 60. The charts account for differing income levels and provide savings percentages that are needed in order to provide replacement incomes of 60 and 80 percent upon retirement. The Journal also included an important denominator -- a column that instructs investors how to adjust savings rates based current retirement accounts. For instance, a 35-year-person with an income of $100,000 needs to save 17.6 percent of current income to achieve a post-retirement income of 80 percent of pre-retirement cash flow. This calculation also includes a "deduction" rate of 0.34 percent, meaning that, for every $10,000 the person has in current retirement savings, the savings rate can be reduced by 0.34 percent to achieve the same results.
CNN Money's Walter Updegrave, in a 2007 article, suggests a 10 percent 401k savings rate, accomplished through direct deposit or other automatic savings methods. The Balanced Money Formula was popularized by -- and often plagiarized from -- the book "All Your Worth: The Ultimate Lifetime Money Plan" by Elizabeth Warren and Amelia Tyagi. The website summarizes the formula as a simple ratio or 50-30-20, meaning people should spend 50 percent of income on needs, 30 percent on wants and 20 percent on savings.
He who Hesitates . . .
A 25-year-old who begins saving $200 a month in a high-interest savings account averaging 3 percent annually, compounded monthly, would accumulate $185,000 pre-tax dollars by age 65. Waiting until age 45 to start saving, that same person would have only $85,000 at age 65. A 40-year-old who wishes to have $185,000 at age 65 would need to sock away $415 a month in the same savings account.
- Kiplinger; Retirement Savings Calculator; May 2010
- "Journal of Financial Planning"; National Savings Rate Guidelines for Individuals; Roger Ibbotson, Ph.D., et al; April 2007
- CNN Money; Retirement - How much to save; Walter Updegrave; January 2007
- Get Rich Slowly: The Balanced Money Formula
- Savings Accounts.com: A Simple Formula for Painless Retirement Savings
- CNN Money: Ask the Expert
- Fox News; How Much Should You Be Saving for Retirement?; Gail Buckner, CFP; July 2007
- "Chicago Tribune"; How Much to Put Away? It Depends; Humberto Cruz; April 2007
- CNN Money; $1 Trillion Question: How Much Do I Need to Save?; W. Updegrave; December 2006
- Dave Ramsey: Monthly Cash Flow Plan
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