Retirement: Is Consistent Saving More Important Than How Much We Withdraw?

We, and loads of others, have written about the importance of understanding safe or sustainable withdrawal rates when saving for retirement. How much will I be able to take out of my savings each year and not end up eating cat food should I be lucky enough to live to 80? Assumptions about this are key to the retirement calculators you find online, for example. The most commonly cited rule of thumb is 4%.

But what if we’ve all been worrying about the entirely wrong thing?

What if what we really should be focused on is saving and investing consistently?

That’s the thesis of a recent paper by (January 2011) Professor Wade Pfau of the National Graduate Institute for Policy Studies in Tokyo, Japan.

Pfau’s research lead him to the following “aha”: if you retire at the end of a long bull market, say, you may enjoy a low withdrawal rate because your savings is so high. But if that bull market is over, you won’t be able to expect much more growth as you move into retirement. On the flip side, if you’re retiring after a terrible bear market, for example, you may be withdrawing a larger percentage in year one and two, but your money stands more chance of continuing to grow in the future, ultimately bringing that percentage down.

Here’s how Pfau explains it on his blog:

Unlike the 4 percent rule, there is not a universal “safe savings rate,” but guidelines can be created. …What is clear is that starting to save early and consistently for retirement at a reasonable savings rate will provide the best chance to meet retirement expenditure goals. You don’t have to worry so much about actual wealth accumulation and actual withdrawal rates, as they vary so much over time anyway. But the savings plan should be adhered to regardless of whether it seems one is accumulating either more or less wealth than is needed based on traditional criteria.

Pfau notes that the focus on withdrawal rates may have lured some of us into not saving enough. “Recent Americans may have not saved enough or retired early because an outstanding market performance may have brought them to their traditional wealth accumulation goals earlier than expected. At the same time, someone saving during a bear market who is nowhere near reaching a traditional wealth accumulation goal may have given up saving or needlessly delayed their retirement, when it is precisely such individuals who could have enjoyed higher withdrawal rates.”

In his writeup of the study on Reuters, Felix Salmon describes Pfau’s basic calculation for what we might have to save:

Pfau makes a very basic calculation that for someone on a constant real wage, saving for 30 years and then living for another 30 years on 50% of their final salary, saving about 16% of your salary each year into a portfolio of 60% stocks and 40% bonds will put you into safe territory.

Of course, real wages aren’t constant over time, and all the other figures are highly variable too. But the bigger message certainly resonates with me: spend less effort on trying to boost your annual returns, when you have very little reason to believe in your alpha-generation abilities, and spend more effort on maximizing your savings every year.

Investing can be exciting, especially when it’s done wrong. You follow the markets rising and falling, you obsess about your retirement-fund balance, you rotate out of this and into that, you read books and magazines and blogs to try to learn more about what to do. You might even, in a moment of weakness, find yourself watching CNBC. Budgeting, by contrast, is like going on a diet: it’s a drag, and it’s hard to get any pleasure or excitement out of it. But the latter is much more likely to get you well-set in retirement than the former.

16% sounds steep, but somewhat possible. Of course, we don’t save anything like that right now — in 2009 the average American put just 10.1% of their paycheck into pension and retirement.

Correction: Professor Pfau’s was incorrectly identified as a professor at Princeton University in the original post. That is where he earned his PhD. He is a tenured Associate Professor at the National Graduate Institute for Policy Studies in Tokyo, Japan.

8 thoughts on “Retirement: Is Consistent Saving More Important Than How Much We Withdraw?

  1. Kathryn

    Hi Nanette, what confuses me is why does everyone assume that we will live off of 50% of our final salary? My parents are in their 60’s and they’re *not* slowing down, they love to travel, play golf ie do things that cost money like a lot of the boomers. I’m 33 years old and feel like I need to have millions in my 401k when I retire because I want to enjoy my golden years like my parents. My question is, do people really only plan to spend 50% -80% of their final salary during retirement, don’t people feel crimped because that’s a huge change in lifestyle? Doesn’t sound like a fun way to grow old.

  2. Nanette Byrnes Post author

    Kathryn — The question your asking is a great one, and central for anyone thinking about retirement. How much will we need to live the way we wish to in retirement? Someone who’s done a lot of thinking about this question is Mike Piper. He recently posted a piece that outlines basic questions we have to answer to figure this out. I will tell you, when I read his book “Can I Retire?” I was chilled at the prospect of how much I need to save (and how far behind I am!). That said, you’ve got lots of working life ahead of you and if you think about this now and make a plan you’ll be in far better shape than you may fear. That process could both help you save what you need (since it will be more real to you) and also set reasonable expectations for what you’ll be able to do in retirement. With a little creative thinking people seem to be able to live pretty well post-paycheck. (Living in New Zealand for example sounds pretty lovely.) If you want to check out an interview I did with Mike Piper here’s the link for that.
    Thanks for reading!

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  4. Wade Pfau

    Dear Nanette,
    Thank you very much for writing about my article! I wish I was a Princeton professor. My Ph.D. is from there, which is a whole order of magnitude less difficult to do than to be a professor there.

    But about the first comment to your article, this is becoming the main question people have, and I need to work better to explain this. But here is an answer:

    First, everyone needs to decide for themselves what their appropriate replacement rate is. That being said, as a baseline, 50% is not necessarily too low. This is just the amount coming from your retirement savings portfolio. People will probably be entitled to Social Security beyond this, and may have other pensions, or plan to do part-time work that would all be added on top as well. Also, because after retiring, you no longer have to save for retirement or pay the Social Security payroll tax, your replacement rate is higher in terms of what you actually had available to spend before you retired. So in the end, the “50% replacement rate” should work out to be a pretty decent replacement rate after adding things like Social Security and in terms of what you could actually spend before retiring, even possibly over 100% of pre-retirement spending power for some people.

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  6. rmark

    ‘what confuses me is why does everyone assume that we will live off of 50% of our final salary?’
    In Pfau’s paper he assumes 50% from investments + SS or pension income , so in total more like 70% – 80% from all sources.

  7. Dan Griffin

    In response to some of the comments about living off of 50%-80% of your salary — I believe the answer is this. When you are in retirement, you don’t have a lot of the expenses you had in your prime. The one that people sometimes forget is the savings piece. Let’s say for round numbers my wife and I make 100k together. If we are saving 20k, we are essentially living off of an 80k salary. In retirement, you are in a withdrawal phase, not an accumulation phase, so the savings piece won’t be needed.

    I believe a lot of planners also assume that by the time you have retired, a lot of the costs of adulthood are behind you (mortgage, paying off debt or student loans, helping children get established, etc.)

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