Are you wondering: How much savings should I have by 40? Good! Once you are 40, you are considered middle-aged, whether you like it or not. At age 40, you should have your life together with a solid career. You might even have a family as well. Your 40s is a very important time in your life!
By age 40, you should have saved at least 6X your annual expenses. In other words, if you spend $80,000 a year, you should have at least $480,000 in savings. You don't need to have 6X in annual cash savings. You can consider 6X your annual expenses as a proxy target for your net worth.
To retire comfortably, you ultimately need to have at least 25X your annual expenses or 20X your average annual income covered. If you don't save or accumulate a net worth equal to these multiples, you will either not retire or never feel truly comfortable retiring.
I'm 43 years old and retired in 2012 at age 34. I had about $80,000 in passive income. But also had a gainfully employed wife! It was only three years later did my wife retire early with me as well.
Pre And Post Tax Savings Guide By 40
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 2021 is $19,500. 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 40
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
Note: Focus on the ratios, not the absolute dollar amount based on a $65,000 annual income. Take the expense coverage ratio and multiply by your current gross income to get an idea of how much you should have saved.
Savings In Your 20s And 30s
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.
Savings By Age 40 And 50
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 3-10X worth of living expenses in your 40's means that you are coming ever close to being financially free. You've hopefully built up some passive income streams a long the way, and your capital accumulation of 3-10X your annual expenses is also spitting out some income.
Your 50s: You've accumulated 7-13X 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.
Savings In Your 60s And Beyond
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%.
Important Note: Obviously no one ever knows what might happen to provide a boost or a drag to their finances. Maybe you get lucky with a great new job offer or invest in the next Apple Computer. Or maybe you get laid off at 40 and can't find work for two years. My chart above merely serves as a savings guideline. Work to build alternative income streams in the meantime.
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 before the pandemic was only around 6%.
During the pandemic, the U.S. saving rate shot up to as high as 30%. Therefore, it shows that if Americans WANT to save, they can. You can save at least 6X your annual expenses by age 40.
Invest Your Savings Wisely
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.
n 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
Take a look at my two favorite real estate crowdfunding platforms. The are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot more capital, you can build you own diversified real estate portfolio.
Track Your Finances Like A Hawk
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!
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 to manage my finances. Now, I can just log into one place to see how my stock accounts are doing. I love tracking my net worth progression as well with PC.
One of their best features is their 401K Fee Analyzer. It is 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.
Strong Savings By 40 Is A Must!
If you want a good amount of savings by 40, you must focus. Continuously increase your saving rate each month until it starts feel uncomfortable.
I started savings 50%+ of my after-tax income after my first month of working in banking. I kept increasing my saving rate as I made more money by keep my expenses the same.
Today, I can be a stay at home dad to my two young kids thanks to my passive income portfolio that generates about $300,000 a year. Remember, saving aggressively is only one part of the equation. The second part is investing wisely.
Personally, as we come out of the pandemic, I think real estate is the best asset class to build wealth. You can own rental properties, ETFs, REITs, eREITs, and individual commercial real estate deals. Inflation acts as a tailwind for real estate capital appreciation while reducing the real cost of debt.