• Briefly Noted
  • Adjust Savings Rates as Income Rises

    An adjustable approach to retirement savings may improve the odds of success. Researchers at Dimensional Fund Advisors suggest workers adjust their savings rate as their income increases over the span of their careers.

    A worker who consistently saves from age 25 until retirement at age 66 will need to put away 16.8% of his salary annually to replace 40% of his preretirement income with a 95% probability. Their suggested savings rates include employer contributions. The portfolio allocation used is a mix of global equities and fixed income. The allocation is adjusted annually based on the exposure to stocks equaling 120 minus the worker’s age.

    Changes in age or the savings rate alter the equation. A worker who starts at age 30 will need to save 19.5% of his income, while a worker who starts at age 35 will need to save 23.8% of his salary to achieve a 95% probability of having enough to adequately replace his income in retirement. A 35-year old who saves 19.2% of his income instead will see the probability of having enough in retirement decline to 90%. At an 8.7% savings rate, the probability of success falls to 50%.

    Changes in income also alter the outcome. The researchers calculated the highest failure rates of not meeting the target income replacement rate among households with steep income growth. This necessitates a change in savings rates as income rises. For example, a 25-year-old making $48,000 can start by saving 6.6% of his salary. When he reaches a peak income of $120,000 by age 45, he should save 17.6% of his salary. Doing so will give him a 90% rate of success.

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    Discussion

    Jeff Horne from WA posted 10 months ago:

    Question: Dimensional Fund Advisors (DFA) funds do not seem to be included in any of the AAII Guides to Mutual Funds - why is that?


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