The quick answer to how much you should have saved by age 45 is 8X your annual expenses. In other words, if you spend $50,000 a year, you should have about $400,000 in savings. Your ultimate goal is to achieve a 20X expense coverage ratio in order to retire comfortably.
If you want to achieve financial independence, you've got to implement an aggressive savings routine. If you are serious about living life on your own terms, study my recommended savings chart carefully.
Let's look at the methodology!
Pre And Post Tax Savings Guide
I recommend everybody start off with 10% and raise their savings amount by 1% each month until it hurts. If you've ever had braces, you get the idea. Keep that savings rate constant until it no longer hurts, and start raising the rate by 1% a month again. If you make more than $200,000, certainly shoot to save more if you can. You can theoretically achieve a 35%+ savings rate in two short years with this method!
Please note that I am making 401K and IRA contributions a priority over post-tax savings. The reasons are: 1) we have a tendency to raid our post tax savings, 2) tax free growth, 3) untouchable assets in case of litigation or bankruptcy, and 4) company match. Obviously you need some post-tax savings to account for true emergencies. Ideally, my goal for everyone is to contribute as much in their pre-tax savings plans as possible and then save another 10-35% after tax.
The maximum 401k contribution for 2018 is $18,500. The maximum pre-tax contribution will probably increase by $500 every two years or so if history is any guidance.
Recommended Expense Coverage Ratio By Age 45 & Beyond
If you're at or around the age of 45 you may be wondering what expense coverage ratio to use. The below chart is an expense coverage ratio chart that follows someone along a normal path of post college graduation until the typical retirement age of 62-67. I assume a 20-35% consistent after tax savings rate for 40+ years with a 0-2% yearly increase in principal due to inflation.
The other assumption is that the saver never loses money given the FDIC insures singles for $250,000 and couples for $500,000. Once you breach those amounts, it's only logical to open up another savings account to get another $250,000-$500,000 FDIC guarantee.
Expense Coverage Ratio = Savings / Annual Expenses
Using my guidelines below, at age 45 you should aim for an expense coverage ratio between 4.0-8.0. Let's look further into the recommendations by decade.
Note: Focus on the ratios, not the absolute dollar amount based on a $65,000 annual income.
Your 20s: You're in the accumulation phase of your life. You're looking for a good job that will hopefully pay you a reasonable salary. Not everybody is going to find their dream job right away. In fact, most of you will likely switch jobs several times before settling on something more meaningful. Maybe you are in debt from student loans or a fancy car. Whatever the case, never forget to save at least 10-25% of your after tax income while working and paying off your debt. If you have the ability to save 10-25% after tax, after 401K and IRA contribution up to company match, even better.
Your 30s: You're still in the accumulation phase, but hopefully you've found what you want to do for a living. Perhaps grad school took you out of the workforce for 1-2 years, or perhaps you got married and want to stay at home. Whatever the case may be, by the time you are 31, you need to have at least one years worth of living expenses covered. If you've saved 25% of your after tax income for four years, you will reach one year of coverage. If you saved 50% of your after tax income a year for five years, you will have reached five years of coverage and so forth.
For Age 45
Your 40s: You're beginning to tire of doing the same old thing. Your soul is itching to take a leap of faith. But wait, you've got dependents counting on you to bring home the bacon! What are you going to do? The fact that you've accumulated 4-10X worth of living expenses in your 40s means that you are coming ever close to being financially free. You've hopefully built up some passive income streams a long the way. Momentum is your friend. If you're age 45, don't give up yet. Keep at it!
Your 50s: You've accumulated 8-13X your annual living expenses as you can see the light at the end of the traditional retirement tunnel! After going through your mid-life crisis of buying a Porsche 911 or 100 pairs of Manolo's, you're back on track to save more than ever before! You are 100% in tune with your spending habits, therefore, you raise your savings rate by another 10% to supercharge your final lap.
Your 60s: Congrats! You've accumulated 10-20X+ your annual living expenses and no longer have to work! Maybe your knees don't work either, but that's another matter! Your nut has grown large enough where it's providing you hundreds, if not thousands of dollars of income from interest or dividends. Full Social Security benefits kick in at age 70 now (from 67), but that's OK, since you never expected it to be there when you retired. You're also living debt free since you no longer have a mortgage. Social Security is a bonus of an extra $1,500 a month. You're budgeting a couple thousand a month for health care as you plan to live until 100.
Your 70s and beyond: Sure, you've been spending 65-80% of your annual income every year since you started working. But now it's time to spend 90-100% of all your income to enjoy life! They say the median life expectancy is about 79 for men and 82 for women. Let's just bake in living to 100 just to be safe by taking your nut, and dividing it by 30. For example, let's say you live off $50,000 on average a year and have accumulated 20X that = $1,000,000. Take $1,000,000 divided by 30 = $33,300. You're getting another $18,000 a year in Social Security, while the $1 million should be throwing off at least $10,000 a year in interest at 1%.
Save And Save Some More
The only way to reach financial independence is if you save and learn to live within your means. National average money market accounts are yielding a pitiful 0.1%. Meanwhile, the average US personal savings rate is still under 6%!
For the money you are comfortable risking, actively invest the rest of your after-tax savings in real estate, the stock market, bonds, real estate crowdfunding, and basically anything else that matches your risk tolerance. The point is to gradually expand your savings into investments where you feel most comfortable. Many people, including myself, love real estate because we can see what we are buying.
Although Social Security will likely be there for those of us when it's time to retire, it'll likely only pay out 70% – 80% of what's promised due to the underfunding. I strongly suggest not counting on any type of assistance from anybody. The only person you can count on is yourself!
Further Recommendations If You're Age 45
It's important to then track your investments to make sure you're comfortable with your positions. I highly recommend signing up for Personal Capital, a free online wealth management tool that let's you easily monitor your finances. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into one place to see how my stock accounts, how my net worth is progressing, and whether my spending is within budget.
One of their best features is their 401K Fee Analyzer which is now saving me more than $1,700 in portfolio fees I had no idea I was paying. They also have a fantastic Investment Checkup feature that screens your portfolios for risk.
Finally, they came out with their incredible Retirement Planning Calculator that uses your linked accounts to run a Monte Carlo simulation to figure out your financial future. You can input various income and expense variables to see the outcomes. Definitely check to see how your finances are shaping up as it's free.
How Much Savings Should A 45 Year Old Have is a FinancialSamurai.com original post.