Are We Saving Too Much For Retirement?

Executive Summary

Are we saving too much for retirement? Can we even be saving too much for retirement? The usual rule of thumb, “Save 20% of your income for retirement” tends to result in saving too little for retirement (relative to our spending before retirement). Modified rules like “Save 33% of you income for retirement” or “Save $100,000 by the time you are 30” end up sacrificing too much of our spending in the early years of our career in favour of retirement spending.

It is actually not that hard to save enough for retirement while spending enough during our working years. But we tend to overdo savings because of psychological reasons, trying to control what we can in an uncertain world. Or through poor investment actions, either by choosing poor investments, and having poor investment behaviours. So, the answer we find is really that we are saving sub-optimally for retirement.

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Introduction

Are we saving too much for retirement? Is it even possible to save too much? If you believe any of the surveys which financial institutions put out every year, then it appears that we as a whole are not saving enough. In fact, this survey says that we only put aside 7% of our income for retirement, and instead should be saving 20%! But how true is this? And how believable is this, coming from institutions such as banks and insurers which have a vested interest in us believing that we save too little and will be only too happy to sell us something to help us save?

How much should we be saving for for retirement?

Let’s consider what else we know about how much we are saving for retirement. The Central Provident Fund (CPF) is probably where most of us have the bulk of our retirement savings. And as seen from the latest figures, we have more than ever in our CPF accounts (see below). We don’t really see the CPF Board asking us to save more over and above our CPF contributions from work. And this is the one institution which has the biggest vested interest in us saving enough for retirement! So could it be that we can end up saving too much for retirement?

We have a lot of savings in our CPF accounts!

Is 20% the correct savings rate for retirement?

The usually advice we get is that we should save 20% of our income towards retirement. And we should save as early as possible during our working years so as to allow the savings the maximum amount of time to benefit from compounding returns when invested. Is this realistic?

Let’s use an example we have seen before to test this out. Suppose our hero or heroine gets a job straight out of school, initially earning $2,500 a month (12 months plus a 3 month bonus every year), and getting an raise of 4% every year, and a promotion of 10% every 5 years, until he or she hits a maximum monthly pay of $15,000 a month after 35 years on the job. A salary of $15,000 a month may seem high at first, but if you only get it in 35 years time, it is worth less than $7,500 a month when you first started! So this is a pretty realistic (if below average) scenario.

Let’s also suppose that our hero or heroine diligently saves 20% of his pay from the age of 25, and maintains this rate of savings over 40 years. And then invests the savings at a return of 5% a year. What is the final sum upon retirement at age 65? Well, it turns out that he or she will have accumulated $2.068 million by that time. At a 4% rate of withdrawal over a retirement of 30 years, this amount gives a monthly allowance of $6,893 a month. Not bad!

But this actually represents a step down for our hero or heroine upon retirement. Since he or she is saving 20% of income, 80% of income is spent, and at an income of $15,000 a month at age 65, he or she would have been spending $13,500 a month at that point. Less, if we take 10% off for taxes, and perhaps more also goes towards paying off any loans prior to retirement. However, this means is that our hero or heroine faces a drop in living standards of almost a half upon retirement. Not really a retirement which I would be looking forward to!

Is there a level of savings which would help to equalise the standard of living before and after retirement? Well, there is. What if our hero or heroine instead saved 32.5% of income for retirement from Day 1, and invested it at a return of 5%? At the age of 65, he or she would have accumulated $3.36 million, which will give an allowance of $11,201 a month in retirement! This is close to the last spending amount of $11,156 prior to retirement. These two savings rates are shown in the table below. So, is 30% the ideal savings rate for retirement?

Retiring on 20% and 32.5% savings rate

	20% Savings Rate	32.5% Savings Rate
Amount at age 65	$2,068,000	$3,360,000
Monthly alowance in retirement	$6,893	$11,201
Spending before retirement	$13,500	$11,156
Drop in living standard	50%	0%

How much should we save for Retirement? A Theoretical Approach

Unfortunately, a 30% savings rate for retirement requires a huge sacrifice from our hero or heroine over a lifetime. Just as we do not like it if we have to take a sharp drop in living standards at the point of retirement, preferring to have spending more or less equal across time, the same holds throughout the 40 years spent working and saving. Saving 30% or more of our income from Day 1 for retirement simply means that we will end up living like a beggar at the start of our careers, and slowly learning to live like a king (or queen) at then end of our career. It looks like something like this:

Savings, Spending and Income Against Age if 32.5% of Income is Saved Every Year

If we look at it in real, or inflation-adjusted values, the amount of spending will still rise over time, making our consumption uneven over time.

Real Spending and Income Against Age if 32.5% of Income is Saved Every Year

What might be preferable is to try to maintain spending in real terms at a constant level over time, as our spending is habitual, and not easy to adjust to suddenly. Also, some spending and consumption also require time and energy, and hence we do not want to deprive ourselves of some of the spending (e.g. on travel, sports and adventures) which can really only be done when we are younger. This might mean spending over time like this:

Real Spending and Income Against Age in An Ideal World

This sort of spending over time can be hard to achieve in practice, because it means that we should spend more than we earn at the beginning of our career. Which means borrowing to spend. In general, most would think it is a bad idea to do this, and besides, it would be hard to find any bank willing to lend for consumption at a low enough rate of interest. No excessive credit card spending, please! But what this also means in practice, is that we may be better off not saving so hard at the start of our careers, and spending a little more, and then catching up later on.

In fact, if there are no other sources of savings other than from our salaries, starting to save 10% of our income from the age of 35, and then increasing the savings rate by 2% every year until it peaks out at 50% of income may help us smoothen our spending to a level where we get to enjoy our youthful energies and curiosities at the start of our careers, without giving up much in terms of savings for retirement.

Savings, Spending and Income Against Age Starting only at Age 35, and Increasing Over Time

This variable rate of savings, starting from age 35, will still allow us to reach a spending level of $9,375 per month when transitioning form employment to retirement, all the while keeping the real value of spending flat over time. If we consider our CPF Special Account as a core part of our retirement savings, we do not even need to start saving seriously for retirement out of our disposable income until the age of 40! This is because when our savings in the Special Account move into CPF LIFE, it will provide some $2,300 a month in retirement.

Most advice we get on how much to save is not really optimal for the way we prefer to live our lives

In particular, advice on saving for retirement like:

• Save at least 20% to 30% of our disposable income
• Aim to save $100,000 by the age of 30

are probably well meaning, but misguided, as it will force us to actually spend less than what we can over our lifetimes.

Why do we continue to save so obsessively for retirement?

Despite this, many of us continue to save obsessively from a young age for retirement. And in doing so, deprive ourselves of some great experiences and memories we can have when we are younger. Why do we do this?

There can be several reasons for this:

1. It could be psychological. There are very few things in life we can control with any degree of certainty, for example how our salary and incomes grow over time, our employment etc. Savings is one of the very few things we can control, and hence we do so obsessively, hoping that it makes up for all the other things we cannot
2. We do not really know how best to grow our savings. As a result, we see little growth in our wealth apart from the amount saved, or returns come too slowly. In turn, we try to save even more

In a previous blogpost, we wondered why there are so few millionaires here even though we are one of the richest countries in the world. Remember that all we need to do to become a millionaire is to save modestly, and achieve pretty modest returns of 5% per annum over time. And we conclude that part of the reason for this is that we often have poor habits when it comes to managing and growing our savings and wealth. This comes in two main forms:

A. Choosing poor investments

Examples of this would be:

• Putting savings into bank deposits which pay extremely low interest rates
• Purchasing insurance endowment polices with their low returns
• Buying whole life and investment-linked policies, which have layers upon layers of fees
• Over-investing in property, which again have layers upon layers of costs, stamp duties, taxes, loan interest, all of which add up and require a long holding period to break even
• Investing in products with high fees

B. Poor investment behaviours

As outlined previously, these would be actions and behaviours such as:

• Withdrawing investments at various points, hence breaking the process of compounding returns
• Dividend investing for income, instead of re-investing the dividends
• Attempting to time the market by keeping cash to invest when the market corrects
• Stock picking

Interestingly, the more “hands-on” an investor you are, the more likely that you are to have some or even all of these behaviours, resulting in poorer returns. This is something which affects virtually all savers and investors, no matter how rich or experienced they are. In a really interesting piece of research on the asset allocations and returns in the portfolios of the wealthy (defined as having US$500,000 to more than US$100 million of assets under management at advisors or private banks, Balloch and Richers (2021) found that almost all of them underperformed the stock market index in terms of their equities allocations over the period 2016 to 2020. What is more, the less wealthy performed worse than the wealthy, as shown below:

Realised Returns for Equities Portfolios (2016 – 2020) before Advisor/Platform fees

Total Wealth Category	Equities Portfolio Return
< US$ 3 million	7.48%
US$ 3 million – US$ 10 million	8.52%
US$ 10 million – US$ 30 million	8.41%
US$ 30 million – US$ 100 million	9.19%
> US$ 100 million	9.59%
S&P 500 market return	9.52%

Anecdotally, the main reasons for the poorer performance for those portfolios less than US$3 million are primarily from trying to do stock picking, market timing, and from holding excessive cash, waiting to for a market correction (which comes less often than anticipated). The larger portfolios do better, probably because they are more “hands-off” investors. Given the size of the assets, they obviously prefer to let their advisors, private bankers or family offices do the investing directly.

Hence, the typical received wisdom as to why small investors can do better than professionals, e.g. do not need to be invested all the time, can pick stocks outside of the market indices etc. basically help to perpetuate poor investing behaviours, which lead to poorer returns on average. And this in turn increases the urgency to save more, to make up for these poor returns on savings and investments.

Are we Saving Too Much for Retirement? Conclusions

We started off asking the question whether “Are we saving too much for retirement?“. And the answer we find is really that we are saving sub-optimally for retirement. The usual rule of thumb, like “save 20% of your income for retirement” tends to lead us to saving too little for retirement (relative to our spending before retirement). Modified rules like “save 33% of you income for retirement” or “save $100,000 by the time you are 30” end up sacrificing too much of our spending in the early years of our career in favour of retirement spending.

Instead, what we might do is to smooth out our spending (in real or inflation-adjusted terms) over our lifetimes (both before and during retirement). And this implies that we should start saving for retirement a little later in life (say around the age of 35 or 40), and then save an increasing portion of our income as it goes up over time.

We can save enough for retirement if we start doing so from the age of 35 or even 40, as long as we do it intelligently!

And we should start to manage the returns on our savings and investments better. All it takes is for us to achieve an average compounded return of 5% on our savings and investments from the age of 35 or 40. But even this low bar seems hard to achieve, primarily due to our poor investing choices and behaviours, which are mainly due to a misguided and unsubstantiated belief that we can do better as part-time, amateur investors through market timing and stock picking! Just stop doing that!

References

Cynthia Mei Balloch and Julian Richers (2021) Asset Allocation and Returns in the Portfolios of the Wealthy, NBER Conference Papers

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