Top Rules of Thumb for Retirement Savings

The best way to plan for retirement is to break it down into small, manageable steps. With that in mind, here are the five most important rules of thumb to follow when saving for retirement.

Key Takeaways

• You should save 15% of your income for retirement.
• When choosing a fund, the closer the expense ratio is to 0%, the better.
• Don’t let salespeople or advisers talk you into buying something you don’t understand.

1. Start Saving Now

Ideally, you would have started saving for retirement the moment you started earning income, which for many of us was at 16 when we got that after-school job at the mall or the movie theater or the sandwich shop. In reality, you probably spent that money on short-term expenses.

It probably didn’t make sense, or even occur to you, to start saving for retirement until you got your first full-time job, had kids, celebrated a milestone birthday, or experienced some other defining event that got you thinking hard about your future.

No matter what your age today, don’t lament the years you didn’t save. Just start saving for retirement now. The sooner you start, the less you have to contribute each year to reach your savings goal, thanks to the benefits of compound interest.

2. Save 15% of Your Income

A good rule of thumb for the percentage of your income you should save is 15%. That’s after taxes and before any matching contribution from your employer. If you can’t afford to save 15% right now, that’s okay. Saving even 1% is better than nothing. Each year when you file your taxes, you can reevaluate your financial situation and consider increasing your contribution.

If you’re older and haven’t been saving throughout your working life, you have some catching up to do, and you should aim to save 20% to 25% of your income for retirement if you can. But if that’s not realistic, don’t let an all-or-nothing attitude defeat you. Just getting into the habit of saving and investing, no matter how small the amount, is a step in the right direction.

Read about Investopedia’s 10 Rules of Investing by picking up a copy of our special issue print edition.

3. Choose Low-Cost Investments

Over the long run, one of the biggest factors in how large your nest egg becomes is the investment expenses you pay. The most common investment costs are the expense ratios charged by mutual funds and exchange traded funds (ETFs), and the commissions for buying and selling.

“The power of compound interest doesn’t just apply to returns, but also expenses,” says Mark Hebner, founder and president of Index Fund Advisors, Inc., in Irvine, California. “The more you pay, the less you keep. Simple as that. And research has shown that cost is the biggest determinant of ending wealth for investors.”

The expense ratio is an annual percentage fee you’ll pay for as long as you hold the fund. If you have $10,000 invested in a fund with an expense ratio of 1%, your fee is $100 a year. You can find a fund’s expense ratio at an investment research website like Morningstar or on the website of any company that sells the fund.

When choosing a fund, the rule of thumb to follow is the closer the expense ratio is to 0%, the better. That being said, it’s reasonable to pay closer to 1% for certain types of funds, like international funds or small-cap funds.

There are two simple ways to minimize commissions. One is selecting commission-free investments. If you buy a Vanguard index fund directly through your Vanguard account or a Fidelity mutual fund directly through your Fidelity account, you probably won’t pay a commission. The other is buying and holding investments instead of making frequent trades—another good retirement strategy we’ll address momentarily.

Get the lowdown on index funds and read our mutual fund tutorial if you don’t know anything about these popular investments.

4. Don’t Put Money in Something You Don’t Understand

If the only investment you currently understand is a savings account, park your money there while you learn about slightly more sophisticated investments like index funds and ETFs, which are the only investments most people need to understand to build a solid retirement portfolio.

Don’t let salespeople or advisers talk you into buying something you don’t understand. They might have your best interests in mind, or they might be trying to sell you an investment that will earn them a commission. Until you educate yourself about different investment options, you’ll have no way of knowing.

Even putting your money in a relatively simple investment like bonds can backfire if you don’t understand how bonds work. Why? Because you might make irrational, emotion-based buy-and-sell decisions based on what you hear and read in the news about how the markets are performing short term, not based on your bonds’ long-term value.

“The best and brightest investors in the world are always trying to find the next great investment for their portfolio. If you are not a full-time investor with an expertise in that investment, you will be at a disadvantage to those who are. Focus on your strengths and that is what will give you your best probability of success,” says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Massachusetts.

5. Buy and Hold

Adopting a buy and hold investment strategy means that even if you choose investments that charge a commission, you won’t pay commissions very often. This rule of thumb also means that you won’t let your emotions dictate your investment decisions.

When people follow their emotions, they tend to buy high and sell low. They hear how high a stock has gotten, and they want in because it seems like a great investment—and it is, if you’ve already been holding it for years. Or, when the economy slides into a recession, people panic about how far the Dow has fallen and dump their S&P 500 index fund at the worst possible time.

Numerous studies have shown that you’re better off keeping your money in the market even during the worst of downturns. Over the long run, you’ll come out far ahead by leaving your portfolio alone through the market’s ups and downs compared to people who are always reacting to the news or trying to time the market.

“Basically, investors are found to be horrible at market timing and stock picking,” says Michael Zhuang, founder of MZ Capital Management in Bethesda, Maryland. “That’s why they should stop doing what they are bad at.”

What Is the 4% Rule?

The 4% rule is a strategy that states how much you can safely withdraw from a retirement portfolio: it’s 4% each year, adjusted for inflation. So if you have a $1 million portfolio, you can withdraw $40,000 the first year. The following years you would withdraw $40,000, adjusted for inflation.

What Is the 50 / 30 / 20 Rule?

50 / 30 / 20 is a budget that describes where your money should go each month: half should go towards needs, 30% should go towards wants, and 20% should go towards savings.

What Is the 70 / 20 / 10 Rule?

70 / 20 / 10 is a budget that says you should direct 70% of your take-home pay to needs and wants, 20% towards savings, and 10% towards debts.

The Bottom Line

While there’s a lot to learn about saving for retirement, understanding how to save and invest your money is one of the most important skills you’ll ever develop. It means leveraging all the hours of research you’re doing today into years of leisure time in the future. Keep in mind these top five rules of thumb for saving for retirement and you’ll be well on your way to a financially comfortable future.