Retirement: Saving More vs. Higher Investment Returns

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Vanguard’s research department released another study [pdf] comparing ways to increase retirement savings for individuals. Here’s one illustrative example; take the following baseline scenario:

  • Investor begins working at 25, but starts saving at age 35.
  • 12% savings rate
  • Moderate asset allocation (50% stocks and 50% bonds)
  • Salary starts at $30,000 but increases with age

Now, here are three ways in which a worker could increase their final savings balance at retirement (age 65).

  • Option #1. Invest more aggressively with an asset allocation of 80% stocks and 20% bonds, while keeping your 12% savings rate and starting age of 35.
  • Option #2. Raise your savings rate to 15%, while keeping your starting age of 35 and 50/50 asset allocation.
  • Option #3. Start saving at age 25 instead of 35. while keeping your 12% savings rate and and 50/50 asset allocation.

Which single option do you think has the most impact? The results are based the median balance found after running Monte Carlo computer simulations based on 10,000 possible future scenarios for each option.

Scenario Median Balance at age 65 % Increase vs. Baseline
Baseline $474,461
Option #1
(Aggressive asset allocation)
$577,133 22%
Option #2
(Raise savings rate)
$593,077 25%
Option #3
(Start saving earlier)
$718,437 51%

Here’s another chart comparing the median retirement balances (inflation-adjusted) for (1) someone with a 6% savings rate and 80/20 aggressive portfolio and (2) someone with a 9% savings rate and 50/50 moderate portfolio.

(click to enlarge)

The title of the paper is “Penny Saved, Penny Earned”, which matches their suggestion that saving more is more reliably effective as compared to reaching for better investment returns. This information should be helpful for those that would like to avoid stock market stress but worry about giving up those potentially higher returns. If you save more, you can take less risk and sleep better at night while still reaching your goals. Hopefully this will also encourage folks to start saving as early as possible, even it is not an especially high amount.

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  1. Option 4- Save nothing your whole life, but die of a heart attack at age 65 and it doesn’t matter.

    I always find these calculations highly misleading. So if you start investing 10 years earlier you’ll wind up with more money? I’d be quite disturbed if that wasn’t true. There is a downside though… you go 10 years with less money to spend. Money compounds, but so does opportunity cost/memories.

    If you believe these numbers though, option 1 has no downside. It is the only scenario where you don’t have to invest more money but still beat the baseline. The moral of the story should be that young people should be investing more in stocks, not young people should be investing earlier, which obviously they should be doing anyway.

  2. I did a similar calculation for myself when I designed my “when can I retire” spreadsheet. I put my retirement date as the first month I could collect my pension, but the monthly amount I needed to retire was over half my paycheck.

    That bummed me out, and I thought, “Did I not save enough already? What if I doubled the amount I already have in the bank?” It made a difference, but not much. I verified that conclusion by changing my amount in the bank to $0. Not much difference.

    Wow. So I changed my investment return, “What if I think I’ll make a great return?” It made a little difference again, but not as much as I thought it might. So I changed the number back to my modest estimate.

    Finally, I added a year to my retirement date. Now that made a difference. Ultimately, I decided I need to work 5 years past my original date. For that retirement date (age 59), I can afford the amount I have to set aside each month.

    It’s really not unlike saving 5 years earlier. If you want to have more money at retirement, save a few more years. You have to do it either in the front or the back, but that’s how you do it.

  3. Kurt @ Money Counselor says

    Very good–you don’t have to turn over the lion’s share of your savings to Wall Street “money managers” and invest in risky stocks to have a secure retirement. The best strategy is to have a budget that includes regular savings from day 1 of your working career. Nothing beats compounding.

  4. The real flaw here, that wall street uses to pull the wool over everyone’s eyes, is that starting valuations of the underlying assets matter. We can’t just use the average returns for each asset class over 100 years. What if we entered a bear market for bonds and equities? If you were a 60/40 Japanese investor in 1987, you would have received 0% real return to this present day. Plowing money into US stocks at a very high CAPE, and US bonds at record low yields is a recipe for vast disappointment.

    Look deeper in to the data on bear markets and think about alternatives. Don’t just plow money into over-valued asset classes and hope for the best.

  5. Here is a great link to get people thinking outside the box:

  6. Articles like this always frustrate me because they mix and match savings and investing to the point that it’s nearly impossible to figure out what context they’re being used in. Savings apparently can mean savings, money set aside, or retirement plan contributions. Investing usually means speculating, saving, buying an interest in an asset, or something altogether different.

  7. The problems with these studies:

    1. Unrealistic amounts / returns.
    2. Dont take taxes into account.
    3. Dont adjust for inflation.

    If they did, it would not be pretty.

  8. I wouldn’t focus on the actual numbers as much as the relative effect of each action.

  9. great update! At 41, i can honestly say i wish i’d partied less and saved more, and i’m ahead of the nat’l avg in terms of net worth, debt, etc…

    This vanguard report dovetails nicely with Dave Ramsey’s famous expression: you’ve got to live like no one else so that you can live like no one else. (Do with less now so that you can have more later : delayed gratification).

    thanks Jonathan!

  10. Jenna, Adaptu Community Manager says

    So glad I started saving before 25!

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