The Three Levers for Growing Retirement Savings

Saving for retirement (or any other goal) requires making use of three levers: saving, time and returns. Each impacts how much wealth you will have to fund retirement. They are all levers you can pull as well as levers you do not have full control over.

To illustrate how they work together, I use a hypothetical person. We’ll assume they have $100,000 saved, earn $70,000 per year and are saving 7% of their salary each year. We can call this person the average Joe because he approximates the average participant in defined-contribution plans [e.g., 401(k) plans], according to Vanguard. We’ll further assume that Joe is 25 years away from retirement, is targeting an average annual return of 8% and is anticipating the amount set aside for retirement to increase by 2% each year (based on his expectations for average salary increases). The employer match is a simplistic 30% of total contributions.

Based on these assumptions, Joe will have $1.24 million saved at retirement.

Now let’s start pulling those levers. The first lever is his savings rate. If Joe were to save 10% of his salary, instead of 7%, he would have $1.47 million at retirement. At a 15% rate, his savings would be nearly $1.87 million. Joe’s ability to increase how much he saves will obviously be dependent on how much income he can avoid spending. This, in turn, is influenced by his salary. Having more disposable income available makes it easier to save more.

In an alternate universe, Joe keeps his savings rate unchanged at 7% but instead postpones retirement by five years. This would result in him having $1.88 million in savings as well. The reason this approximately matches doubling his savings rate is because the extra five years of compounded growth occurs on a base of $1.24 million. In other words, he has a much larger portfolio to benefit from additional growth.

Now let’s pull the return lever instead. In this universe, the savings rate is kept at 7% and his time to retirement is kept at 25 years. The only change is Joe realizing a 10% annualized return instead of an 8% return. His balance at retirement would be $1.82 million.

While the savings rate would require the proportionately biggest relative change to achieve the same result for someone Joe’s age, it’s still arguably the most important. The higher the savings rate is earlier in one’s career, the more money there is to grow over time. A higher savings rate also provides a bigger buffer against market downturns and periods when contributions may be interrupted (e.g., due to a job loss).

Delaying retirement brings the added benefit of bigger Social Security benefits if claiming is also delayed. It is dependent on a person’s health and job security. If Joe was forced to retire sooner than planned, he would lose out on some of the late-in-career portfolio growth.

Returns can be boosted by adopting and sticking to a more aggressive allocation. Returns are a wildcard because investors don’t get to choose the market conditions they live through. A subpar period of returns would hurt Joe’s outcome. An above-average period of returns could give Joe the financial flexibility of retiring sooner than expected.

Pulling all three levers would have the biggest impact. Joe would have more savings to grow, a longer period to grow his savings and potentially higher returns to increase in his wealth. Plus, doing so helps prepare Joe for periods when he may have to cut back on savings and/or when returns may be negative. As an added benefit, pulling all three levers increases the odds of Joe reaching his goals ahead of schedule.

You can use our retirement savings worksheet to test different scenarios. We’re adding it to our Individual Investor Wealth-Building Process toolkit. It’s a prototype; if you have feedback, please let us know.