Ask the Expert

Saving a considerable amount for your retirement might not be as hard as you think.
By Karen Wallace | 20/08/18

Let's say your goal is to save a million dollars by the time you retire. For many people, that sounds like a Herculean task.

About the Author
Karen Wallace, CFP® is Morningstar’s director of investor education.

What are you picturing right now? If you are imagining squirreling away money for decades and holding it in cash (money market funds have returned just over 1% annually over the past 15 years), you would need to sock away a lot of money to get to a million. And along the way, your budget could be really tight.

Change your mental picture. Instead, invest in your RRSP (or another retirement savings account) with the goal of having a million dollars in 30 to 40 years. Although it may sound like it's just semantics, it's actually much easier -- especially if you start saving early -- to let your investments do as much heavy lifting as possible.

What does it take?

As you might recall, the most you can contribute to an RRSP in 2018 is 18% of your earned income, up to a maximum of $26,230. But the good news is that you don't have to save anywhere near that much per year if your goal is to have a million dollars by age 65, provided you start early. The earlier you start investing, the longer your investment will compound (your money will grow exponentially). You can do the math yourself if you have a financial calculator, but in case you don't have one (or you don't have it handy), here's an example of a 25-year-old who has not yet begun saving.

How to save $1,000,000 by age 65
Amount saved$0 (PV on financial calculator)
Amount we want to have saved by 65$1,000,000 (FV on financial calculator)
Annualized market return expectation6% (I on financial calculator)
Years until 6540 (N on financial calculator)
Yearly contribution to RRSP (PMT on financial
calculator)
$6,461
Dollar amount per semi-monthly paycheque
required ($6,461/24)
$269

What about that market rate of return? How do I know what stocks will return over the next 40 years? The truth is that I don't. If we did know, we would know exactly how much we need to save to reach our goal. But since we don't, we will make educated guesses instead.

I picked a rate of 6% because that's more or less what world equity markets have averaged, after inflation, over the past 50 years, as per the Credit Suisse Global Investment Returns Yearbook 2018. Does that mean your stocks will earn around 6% after inflation in every year going forward? Of course not -- this is just the smoothed-out, average annual return over the past 50 years. Importantly, there is just no accurate way to guess what stocks will do over short-term periods. Over a multi-decade period, though, 6% per year is as reasonable an estimate as any.

Again, though, there are no guarantees. If you want to be more conservative in your estimate, you can use 5.5% or 5% as the return for stocks. The result of lowering the growth rate will be that the recommended savings amount rises: In other words, the market won't do as much heavy lifting and you will have to save more. The downside of saving more in the present is that you may have to keep a pretty tight budget, which can be challenging. The upside, obviously, is that you'll have more money saved.

Don't forget: If your employer provides a pension plan, part of your retirement contribution might come from your employer in the form of a company match. Let's say your employer matches the first 5% of your pension contribution. That means that if you save at least 5% of your paycheck ($2,000 if your base salary is $40,000), your employer will kick in another $2,000. So that means that you only really have to save $4,461 per year (11% of your salary) to get into the ballpark you want to be in.

Is a million going to be enough?

Now that we've figured out how to save a million dollars, we should ask ourselves if that's even an appropriate savings target. It's a considerable amount of money and it's a lot more than many people have when it comes time to retire. But if you have many decades until retirement, inflation takes a toll and you might find that a million dollars just isn't a whole lot of money.

The goal in retirement savings and drawdown is to maintain your current lifestyle, plus or minus some expenses -- maybe more travel spending but less money required for commuting and new clothing. Many people focus on replacing 80% of their pre-retirement paycheck. Remember, too, that government benefits will provide some income in retirement. Also -- and this is something that people sometimes forget -- you still have some earning power in retirement, especially if you maintain a modest allocation to stocks in your portfolio.

For that reason, it's recommended that you base your savings goal on your household's anticipated cash flow needs rather than on an arbitrary number that might be a lot more or a lot less than you will need in retirement, depending on your current salary and lifestyle.

The point is, saving a considerable amount for your retirement isn't impossible. It can be difficult, of course -- especially in the early stages of a career when incomes tend to be lower. But hopefully you can afford to sock away $200 to $300 per paycheck. Though for some it may be out of reach, for others it may be more achievable than they thought.

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