I wish I had a nickel for every time this question has popped in to my head. I thought about this a lot more when my net worth was quite low and I had just gotten started. It’s hard to imagine that you are on the right path to retirement when you only have $10,000 put away in your 401k or IRA.
So how do you know if you are saving enough? It’s never a cut and dried answer. There are so many variables that play in to how much money you’ll need when you retire. You have to consider health care later in life, whether you expect to get any social security money, whether you’ll ever have a pension, or whether you’ll inherit a large sum of money (fat chance for me and I don’t recommend assuming you will get squat).
The conservative approach to deciding whether you are saving enough is to expect nothing. Assume that the only way you’ll live comfortably in retirement is to generate income from money that you have saved/earned by investing. At first that can be a rather frightening thought, but the reality is that most people will HAVE to count on themselves later in life.
Maybe it’s not as bad as it seems. If you were able to amass $1 million dollars by the time you wanted to retire, you would easily generate about $50,000 a year before taxes. Sure, inflation needs to be considered because $50K tomorrow isn’t as much as $50K today but it is significant. With inflation in the mix, maybe you should shoot for $2M.
How do you know if you are headed down the path to at least $1M? Just head on over to an online calculator and do the quick calculation by punching in a couple numbers at this online calculator:
http://www.investopedia.com/calculator/MillionaireCal.aspx
If you are 35 today and want to retire at 65 you need to save $442.38 per month until you are 65 to amass $1 million dollars. That assumes that you have nothing today and will get a 10% return on your money. The calculator also lets you input the total that you have put away today and tells you how much less you need to save to reach the $1M mark.
Every so often I like to visit one of these calculators to check up on where I’m at and to make sure I don’t need to increase my savings rate. I like to change the expected retirement dates around etc to see how much earlier I can retire based on various investment and contribution rates. I’m currently tracking to retirement at 50 or so. That’s the date that I “can” retire, but most likely I’ll push a little farther because the investment gains really pile up at the end of your work career. For every year you can delay, you see significant increases in your nest egg.
The one other “gotcha” in making your decision on how much to save is all the things that can happen in your life. That’s probably the biggest risk to your plans. You could lose your job and fail to find a comparable one. You could experience a death in the family or have some catastrophic event that completely impacts your finances. It’s an endless number of scenarios that could go wrong. With this in mind, I’d recommend “shooting the moon” and saving as much as you can. That doesn’t mean you should completely starve yourself of living for the day, but you should take a long hard look at what you “need” versus what you “want” and make sure you aren’t screwing your future self by paying too much attention to all the “wants”.