Is saving 8 times final salary a financial ‘rule of dumb'?

Most financial rules of thumb have been around for decades, giving guidance like “Subtract your age from 100 to determine the percentage of assets you should hold in stocks,” or, “To retire comfortably, your investments must generate 75 percent of your final salary.”

The advice is more imprecise than incorrect, but it frequently is used as gospel. As the late Lynn Hopewell, former editor of The Journal of Financial Planning, once told me: “Rules of thumb are for people who want to decide things without thinking about them.”

This week, however, Fidelity Investments unveiled what amounts to a new financial rule of thumb, in the form of a set of retirement-savings guidelines based on its research, effectively laying out a roadmap that allows workers to check their progress at key points along the way.

The take-away on the research is likely to be considered the next financial axiom: “Employees need eight times their ending salary in order to meet basic retirement income needs.”

That is the target that people will now be setting, the number they will be aiming for rather than making decisions about a personalized, appropriate savings level.

Before Fidelity’s research moves from suggestion to perceived financial guideline and, potentially, to “rule of dumb,” it’s important to understand what the company was shooting for and how it intended for its numbers to be used.

For starters, Fidelity didn’t just give the final target number, but rather set up check-points, mile markers on the road of life where someone might want to measure their progress toward the ultimate goal.

While acknowledging that every individual situation differs based on someone’s desired retirement lifestyle, Fidelity’s target is replacing 85 percent of pre-retirement income.

Right off the bat, that means they have changed the older rule of thumb that talked about needing your investments to generate three-quarters of your pre-retirement income.

Having sufficient funds to generate 85 percent of your final salary by age 67 will require hitting the benchmark number of eight times final salary, Fidelity said.

Getting there, however, will require that a worker saves about one time their salary at age 35, three times their pay when they reach age 45 and five times their salary at age 55.

The mile markers are based on a hypothetical worker saving in a 401(k) or similar workplace-retirement plan starting at age 25, working and saving continuously until retirement at 67, and living until they reach the age of 92. (It’s important to note that Fidelity said the final goal would include all savings, and not just the dollars set aside in the workplace program.)

Further, that worker is making continuous contributions to their retirement plan, starting at 6 percent of their salary when they start saving at age 25, and rising 1 percent per year until reaching 12 percent. Additionally, the worker is getting an additional, ongoing 3 percent contribution from their employer during their working life.

The money the worker saves grows for life by an annual average rate of 5.5 percent, the employee’s income grows by 1.5 percent over general inflation with no breaks in employment or savings, and the amount of necessary savings would be even higher if it were not for Social Security.

And now you see why people who use rules of thumb don’t necessarily understand what really went into setting the standard. It’s like people using the general belief that “Stocks will return an average of 10 percent per year” without understanding that the historical research underlying that assumption never factored transaction costs – or mutual fund expenses – into the picture.

Go through a period of unemployment or take a few years off to raise kids, and the growth picture changes. Start saving smaller, and you’ll spend most of your life playing catch-up. Fail to get a 5.5 percent average return, or see no pay increases – or inflation swallowing virtually all of any raise – and you’re headed off the road.

And that’s before anyone factors in how changes to Social Security might affect generations of retirement savers.

Do the check-up to see where you stand at any point in time, and you might find yourself deep in the woods. Or, you might find yourself on pace with say, three times your salary saved up at age 45, but unaware of what goes in to making the next interim goal 10 years closer to retirement.

Where this becomes a rule of thumb is in the idea that it doesn’t matter so much where you start, but how you finish, with the 8X salary as a nestegg.

“It’s not like you can start at age 25 or 30 and set it and forget it,” said Jeanne Thompson, vice president, Market Insights at Fidelity “As you age and move along in your career, you need to constantly re-evaluate your savings level and your asset allocation ... to make sure that for the rule of thumb, you are where you are supposed to be.”

Thompson acknowledged that some people might check themselves against the guideposts and be terrified.

“For the folks who might look at this and say ‘I’m not on track,’ the best recommendation is to evaluate where you can make some adjustments,” Thompson said. “Maybe they can start to save a little bit more, they can make sure based on their age that their asset allocation is correct ... and they may want to think about the possibility of having to work longer so that when they do retire they have enough, or adjusting your lifestyle in retirement.

“The vision you have for your retirement, based on what you save, may or may not be able to happen if you are a little bit off-track.”

Ultimately, the takeaway from Fidelity’s research should not be the retirement level – which is what most people will focus on – but the waypoints. If you don’t have a year’s salary saved by age 35, it’s time to start playing catch-up, rather than waiting to see where you stand at 55 and are heading into the home stretch.

The finish line might be the same, but the journey to get there can be easier if you have a good idea that you’re on the right track.