Today we have a guest post from Christian Chan, CFA, and Kandarp Acharya, CFA, FRM, portfolio managers of the Wells Fargo Dynamic Target Date Funds.
When it comes to saving for retirement, the word average gains a much more positive connotation than it has in life.
The topic brings to mind A Prairie Home Companion’s fictional town of Lake Wobegon, where all the children are above average. As a kid from the suburbs, I have spent the majority of my life trying to escape the average. I studied hard (or at least I studied harder than average), I graduated from a good university (it was an above-average university), and then I dutifully joined the workforce, where I now, like everyone else, work harder than the average working American (don’t we all, on average?). But try as I might, I just can’t seem to escape the average. For example, I am below average in height and above average in weight, so that makes me pretty average, right? While this hasn’t done much for my growing midlife angst, the average experience for the American worker, or more precisely the median experience, is an excellent place to start when you’re designing your retirement investment strategy.
The first step to understanding retirement investing is figuring out how much you think you’ll save for retirement. To answer that question, we can start by looking at demographic data for the median American. According to the U.S. Census Bureau,1 the median American earns approximately $54,000 in income per year and follows an income growth path similar to the one displayed in the chart below. Some may earn salaries above the trend line and some below. Either way, it is a pretty good place to start. A couple of observations: First, income growth tends to rise rapidly in the first 10 years of employment. Those of you who read my last post may recall that extra contributions during the first 10 years of your career can make an outsized contribution to your long-retirement success. So take half of that annual raise and put it in your 401(k) plan! Secondly, income levels tend to decline after age 61. It’s no wonder I find myself envying young people more—and not just because they are better positioned to significantly grow their retirement savings than I am right now. Because, to borrow a song lyric from my younger years: “Time is on their side.” Saving a higher percentage of your salary in the early years is a critical success factor.
At any rate, to determine how much we think we’ll save for retirement, we can take our median income data (we could assume a more or less optimistic path if we wanted to) and combine it with the observed 401(k) plan savings rates that we display in Chart 2 (again, we can assume more or less aggressive savings assumptions).
With a little multiplication and a little addition, we can estimate that the average American can be expected to invest about $299,000 in their retirement savings account over the course of his or her career (red line in the chart above). So that answers our initial question on how much we think we’ll put aside for retirement. That is a lot of money to invest over time—but is it enough? If you think about a retirement lifetime that may extend over 30 years or more, $299,000 may not be sufficient to let you have the kind of retirement lifestyle you want. In our next posts, we’ll discuss how we can grow that $299,000 to reach our retirement goals.
1. Census Bureau’s 2015 Annual Social and Economic Supplement of the Current Population Survey