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Joy of saving early and often

By Jennie L. Phipps ·
Thursday, August 16, 2012
Posted: 11 am ET

Probably the most important retirement planning step is to start saving early and often.

Even if you're not able to put away a lot, saving steadily is important because of the power of compound interest.

The first of the two charts below -- provided by J.P. Morgan Asset Management -- demonstrates the advantage of getting into the habit of saving when you are in your 20s.

Take a look at the blue line. It represents Susan's path to retirement. She invests $5,000 annually from age 25 to 35. That's 10 percent of a $50,000 salary, but she could accumulate $5,000 a year on a lesser salary if she's getting a significant corporate match. Over those 10 years, Susan contributes $50,000. If she never saves another dime before her retirement at 65, she'll still have $850,000, assuming an 8 percent return, as long as that interest keeps compounding at that rate.

Growth of savings accounts

Source: J.P. Morgan Asset Management. This chart is for illustrative purposes only and shouldn't be used to make investment decisions.

The gray line represents Bill, who doesn't start saving until age 35 and saves steadily for 30 years until he retires at 65. In total, he saves $150,000, but his nest egg doesn't have as much time to grow, so at retirement, given an 8 percent return, he'll only have $661,000 -- almost $200,000 less than Susan, who only put away one-third as much.

The green line shows Chris as the real winner. He saved $5,000 a year steadily from age 25 to 65 and accumulated more than $1.5 million. Katherine Roy, a Certified Financial Planner and an executive director at J.P. Morgan Asset Management, says, "There are fewer Chrises than there ought to be. While his kind of steady saving isn't likely because of fluctuations over time, most people can save something every year, and that will make a big difference."

The real question you'll need to ask yourself

Charts like these raise the question: How much money do you really need to save to be comfortable in retirement? The answer depends on a variety of factors. You don't need as much to live comfortably in the U.S. heartland as you might if you live in San Francisco. If you can count on an old-fashioned defined benefit pension, then that will reduce the amount you have to save. If Mom and Dad have agreed to give you a $1 million wedding present, that's a nice starting point.

The second chart from J.P. Morgan Asset Management, below, attempts to give people a measuring stick to help them calculate their progress toward salting away enough to continue to live in retirement in the same style they've grown accustomed to during their working years.

How's your progress?

Source: J.P. Morgan Asset Management. This chart is for illustrative purposes only and shouldn't be used to make investment decisions.

Here's how to use the chart:

Multiply your salary by the checkpoint shown to get the amount you should have saved today, assuming no future contributions. (For a 40-year-old making $100,000: $100,000 times 5.1 equals $510,000.)

The calculations assume:

  • Someone earning $50,000 at retirement will need to replace at least 30 percent of his pre-retirement income.
  • Someone earning $75,000 will need to replace at least 37 percent.
  • Someone earning $100,000 will need to replace at least 45 percent.
  • Someone earning $125,000 will need to replace at least 53 percent.
  • Someone earning $150,000 will need to replace at least 61 percent.
  • Someone earning $175,000 will need to replace at least 65 percent.
  • Someone earning $200,000 will need to replace at least 69 percent.
  • Someone earning $250,000 will need to replace at least 74 percent.

A wake-up call for all

This chart also assumes you'll receive Social Security based on a salary that has increased 2.5 percent a year during your working life. As your pay rises, Social Security replaces less and less of it in retirement. That's one reason the percentage amount of savings needed increases as your salary grows.

J.P. Morgan assumes the money will be invested in a 60 percent equity and 40 percent bond portfolio during your working years and a 30 percent equity and 70 percent bond portfolio after you retire. It expects retirement to last 30 years.

Don't be shocked. Roy says this chart is a wake-up call and reminds young people who use it that it doesn't factor in future savings.

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August 17, 2012 at 12:59 pm

Is there a way to find out how much social security a person can draw that would be equal to the amount they paid into it over the years? Inflation would have to be factored in of course because a $100 contribution in 1960 is worth a whole lot more in today's inflation money.

August 16, 2012 at 3:25 pm

The 30 yr old making 50k is supposed to have aleady saved 115k...really? What parallel universe is that happening in?
At the 5k/yr rate shown in Chart 1, he would have had to start saving when he was 7, assuming no compounding, which, unfortunately, is where most of us are over the last decade.
Now, assuming he started at 22, right out of school, he would have to be putting away 14k annually or 28% of his 50k salary, and be getting about 3% return.