The Rule of 30

1. The Rule of 30: A flexible approach to retirement saving

"Save an amount equal to 30 percent of gross pay (combined pay in the case of a couple) less the amount you are paying toward a mortgage (or toward rent if you don't own a home) less extraordinary short-term expenses like daycare costs."

The Rule of 30 provides a more balanced and realistic approach to retirement saving than fixed percentage rules. It acknowledges that life circumstances change and allows for flexibility in saving rates. Here's how it works:

• Calculate 30% of your gross income
• Subtract mortgage/rent payments
• Subtract short-term extraordinary expenses (e.g., daycare)
• The remainder is your retirement savings target

This approach ensures that you save more when you have higher disposable income and less when you have significant expenses. It helps maintain a consistent standard of living throughout your working years while still prioritizing retirement savings.

2. Balancing retirement savings with current lifestyle needs

"It's important to save for retirement, but there is much more to life than retirement. You should be able to enjoy every phase, and that should be easier to do if you save in a way that spreads out the pain over the entire accumulation period."

Finding balance is crucial when planning for retirement. While saving is important, it shouldn't come at the expense of enjoying life in the present. The Rule of 30 helps achieve this balance by:

• Allowing for lower savings rates during high-expense years (e.g., when raising young children)
• Encouraging higher savings rates when expenses decrease
• Maintaining a relatively stable "spendable income" throughout working years

This approach helps avoid the common pitfall of over-saving in early years, which can lead to unnecessary financial stress and reduced quality of life. It recognizes that retirement saving is a marathon, not a sprint, and allows for a more sustainable long-term strategy.

3. Adjusting savings strategy as you approach retirement

"As you get closer to retiring, you should use a retirement calculator, such as PERC, to make final adjustments to your saving rate."

Fine-tuning your strategy becomes increasingly important as retirement approaches. While the Rule of 30 is effective for most of your working life, it's crucial to reassess and adjust in the final years before retirement. Here's why:

• Market performance may have affected your savings more than anticipated
• Your retirement goals or timeline may have changed
• You may need to make up for under-saving in earlier years

Using a retirement calculator like PERC (Personal Enhanced Retirement Calculator) can help you:

• Project your retirement income based on current savings
• Identify any shortfalls in your savings
• Determine if you need to increase your savings rate in the final years

This step ensures that you enter retirement with confidence in your financial preparedness.

4. Optimizing asset allocation with the Target Date Fund approach

"Whether you use target date funds or keep adjusting your asset mix manually, start with a high equity weighting (up to 100 percent) in your portfolio when you are young and gradually increase the bond weighting to an ultimate mix of 50-50 just before retirement."

The Target Date Fund (TDF) approach offers a dynamic asset allocation strategy that adjusts with your time horizon. This method typically outperforms a static 60-40 stock-bond mix. Here's how it works:

• Start with a high percentage of stocks (up to 100%) when you're young
• Gradually increase bond allocation as you approach retirement
• Aim for a 50-50 stock-bond mix at retirement

Benefits of the TDF approach:

• Maximizes growth potential in early years
• Reduces risk as retirement nears
• Provides a disciplined, systematic approach to asset allocation

While you can invest in actual Target Date Funds, you can also apply this principle manually by adjusting your own portfolio over time, potentially saving on management fees.

5. The impact of demographics on future investment returns

"The real reason for the persistently low interest rates we've experienced, and also the reason they will stay low for a long time to come, is demographics."

Demographic shifts are reshaping the investment landscape, particularly in developed countries. As populations age, the ratio of savers to borrowers increases, leading to:

• Persistently low interest rates
• Potentially lower stock market returns
• Challenges for traditional retirement planning assumptions

Key considerations:

• The proportion of people aged 55-80 (savers) to those aged 25-54 (borrowers) is increasing
• This trend is likely to continue for several decades
• Similar patterns have been observed in Japan, which experienced demographic shifts earlier

These demographic changes suggest that future investment returns may be lower than historical averages, emphasizing the importance of starting to save early and considering alternative strategies to meet retirement goals.

6. Choosing between RRSPs and TFSAs for tax efficiency

"When your marginal tax rate is lower, you should make maximum use of TFSAs, to the extent you have contribution room; and when it is higher, you should use RRSPs."

Tax-efficient saving can significantly impact your retirement nest egg. Both Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs) offer tax advantages, but their benefits depend on your current and future tax situations. Here's a general guideline:

• Use TFSAs when:

  • You're in a lower tax bracket (e.g., early in your career)
  • You expect to be in a higher tax bracket in retirement
  • You want flexibility to withdraw funds without tax consequences

• Use RRSPs when:

  • You're in a higher tax bracket
  • You expect to be in a lower tax bracket in retirement
  • You want to reduce your current taxable income

By strategically using both vehicles, you can maximize tax efficiency and potentially increase your after-tax retirement income by up to 10%.

7. The importance of employer-matched contributions in workplace plans

"A matching employer contribution is like getting an instant 100 percent return on your money. This is always valuable but especially in a low-interest era."

Employer-matched contributions in workplace retirement plans offer an unparalleled opportunity to boost your retirement savings. If your employer offers a matching program:

• Always contribute enough to get the full employer match
• Consider this a priority even if it means temporarily exceeding the Rule of 30
• If necessary, consider reducing mortgage payments or taking a low-interest loan to make contributions

The benefits are substantial:

• Immediate 100% return on your contributed funds
• Tax-deferred growth on both your contributions and the employer match
• Potential for significant long-term wealth accumulation

This "free money" from employer matching is too valuable to pass up, even in times of financial constraint.

8. Homeownership vs. renting: Financial implications for retirement

"Bottom line, owning looks to be a little better than renting over the next 30 years. And even if it's not, owning is unlikely to be a bad decision."

The homeownership decision can significantly impact your retirement planning. While historically, owning has often been financially advantageous, the gap between owning and renting has narrowed in recent years. Key considerations:

Factors favoring homeownership:

• Forced savings through mortgage payments
• Potential for property value appreciation
• Stability and control over living situation

Factors favoring renting:

• Greater flexibility and mobility
• Lower upfront costs and maintenance expenses
• Potential for higher investment returns if the savings are invested wisely

The decision should be based on personal circumstances, local real estate markets, and long-term financial goals. While owning may have a slight edge, renting can also be a viable strategy if it allows for disciplined saving and investing.

9. Protecting against unexpected career setbacks

"Plan for the vulnerable years, the time late in a career when you might be forced out of your regular job by your employer or by a health issue; in particular, pay off the mortgage a few years early, just in case."

Building financial resilience is crucial as you approach retirement. Unexpected job loss or health issues in your 50s or early 60s can significantly impact your retirement plans. Strategies to mitigate this risk include:

• Paying off your mortgage early (e.g., 5 years before planned retirement)
• Maintaining an emergency fund
• Continuously updating your skills to remain employable
• Considering disability insurance

Benefits of early mortgage payoff:

• Reduces fixed expenses if income is unexpectedly reduced
• Provides more financial flexibility in later working years
• Allows for higher retirement savings rates in final working years

By preparing for potential setbacks, you can protect your retirement plans and maintain financial stability even if your career doesn't go as planned.

10. The power of compound interest and long-term investing

"If you measure real returns on stocks over 40-year periods, we find they have been quite volatile. Between 1925 and 1964, for instance, the average real return was 8.8 percent. This turned out to be the highest ever over a 40-year stretch, which I found quite remarkable given all the turmoil at the time."

Long-term investing harnesses the power of compound interest, potentially leading to significant wealth accumulation over time. Despite short-term volatility, stocks have historically provided strong long-term returns. Key points:

• Historically, stocks have outperformed other asset classes over long periods
• Real (inflation-adjusted) returns on stocks have averaged 6-7% annually over very long periods
• Even during turbulent times (e.g., Great Depression, World War II), 40-year stock returns remained strong

This underscores the importance of:

• Starting to invest early in your career
• Maintaining a long-term perspective
• Not being deterred by short-term market fluctuations

While future returns may be lower due to demographic and economic factors, the principle of long-term investing in a diversified portfolio remains sound for building retirement wealth.

Last updated: September 10, 2024