How much money do you actually need to save?
Some people don’t save enough. Everybody knows that. But a lesser know truth is that some people save way too much. They are afraid that they will run out of money in retirement, so they deny themselves goods and services, living a life of frustration, only to end up with way too much money at 70 and no energy to spend it.
Here is a brain teaser: how much would you need to give a newborn at birth so that he would have a million francs, at 65, if future stock market returns were in line with historical averages? The answer might shock you: around 12k. That’s not 12 thousand every year. That’s 12k at birth, and that’s it. 12k compounding 7% a year for 65 years, that’s around one million francs. And yes, that accounts for inflation too.
Most of our parents didn’t put 12k in a low-cost index fund when we were born though. And most of us don’t need a million swiss francs at age 65, because the state and your pension fund will already give us a pension.
So, how much do we actually need to have saved on our own at retirement age and to how much money does that correspond now? If you were a newborn and needed one million at 65, you would need to have 12k saved and invested. But if you are 35 and need one million at 65, you would need to have 131k saved and invested, because there is less time for the money to compound (30 years instead of 65 years).
To tackle this problem, we need two information:
1) How much are the state and company pensions going to be?
2) How much capital do you need to make up for what is missing compared to your spending?
Example with numbers
This is a tricky exercise because it depends so much on the different situations. So, in order to make it more practical, let’s make a few assumptions:
– A single man earning 50k per year between age 25 and 65
– This person did not pay the AVS minimum between age 20 and 25
– The company pension (2nd pillar) adheres strictly to the minimums prescribed by the law
– The company pension fund earns 1% per year
– The stock market returns 7% per year
– This person needs a total pension of 50k at retirement age
Let’s calculate the state pension first (1st pillar): According to the AHV table, a person contributing on the basis of 50k per year would be entitled to a full pension of 1900 francs per month. But this guy does not get a full pension because he has only contributed 40 out of the 44 years necessary to full pension. Therefore, his state pension will amount to 1900*40/44 = 1730 francs per month or 20 700 francs per year.
From his company pension (2nd pillar), having accumulated a capital of 152k during his professional life, he gets a pension of 10 300 francs per year. We get this number by multiplying 152k by 6.8% which is conversion rate imposed by the swiss law on the minimum capital. (Note: if your employer is more generous in its contribution than the legal minimum, the conversion rate will be lower.)
Combining the two makes a nice and round 31k per year at retirement. That’s not too far from the 50k he needs.
The missing part
The 19k missing have to come from his savings. How much capital does he need in order to afford withdrawing 19k every year? Well, that depends how long he intends to live, but that’s not often known in advance.
Let’s plan for a reasonable 30 years of retirement and let’s assume that the money isn’t invested. In other words: at 65, he withdraws the entirety of his portfolio and places it on savings account offering no yield. That’s not an advisable strategy, but it’s conservative. In reality, the money would stay invested and he would only need between 20 and 25 times his yearly withdrawal. But let’s plan for 30.
That’s 30 years times 19k (50-31) per year = 570k.
That’s how much he needs at 65. That looks like a boatload of money, right?
But remember the brain teaser at the start of the article: an incredible amount (1 milion) is achievable if there is even time to compound. So, how much does 570k translate to at different ages? Well, that’s where it gets really interesting.
570k at 65 means, assuming 7% growth per year:
– 289k at 55
– 147k at 45
– 75k at 35
– 38k at 25
So, if our friend wanted to retire at 65 and get exactly as much as he did while working, all he would need is 38k saved and invested at 25. But since he’s just starting to work at that time, it’s unlikely that he would just happen to have that much money.
10% for 10 years
So what if he decides to save just 10% of his income: 5k per year, and invest that money in the stock market. How long would he need to reach critical mass? The answer is: 10 years. By saving just 10% of his income for 10 years, he would get enough invested so that he can reasonably expect to retire with exactly as much as he did get while working. At age 35, he wouldn’t need to think about retirement ever again and go back to spending everything he earns, for the rest of his life. No more savings!
Interestingly enough, someone earning 100k throughout their life and wanting to keep spending 100k during retirement would have to save 10% of his salary for 15 years before they can reach the same status. That’s because the first and second pillars are less generous for higher incomes. Therefore, they depend more on their own savings. But it’s arguably easier to save 10k when you earn 100k than to save 5k when you earn 50k.
These results are of course highly dependent on the set of assumptions I’ve listed above, so don’t take the 10% for 10 or 15 years as directly applicable for you. On the contrary, I would invite you to calculate your own number: how much do YOU need to save?