I've read a lot of personal finance books over the years. Most say some version of the same thing. Live below your means. Pay yourself first. Avoid debt like the plague. Invest your savings for the future. Rarely do I see a novel concept that gets me excited to share it far and wide. But that's exactly what author Fred Vettese did with his latest book, The Rule of 30.
Mr. Vettese is a retirement expert, author of the best selling Retirement Income For Life, and a former chief actuary of Morneau Shepell. His retirement planning books are must-reads for Canadians in or approaching retirement.
The Rule of 30 is aimed at a different generation of Canadians: those aged 30 to 45. The book follows a Wealthy Barber-esque fable of a young 30-something couple (Brett and Megan) and their neighbour Jim, who happens to be a retired actuary. Similar to The Wealthy Barber tale, Brett and Megan have a series of weekend discussions with Jim to figure out how to save for retirement.
What exactly is this magical rule of 30?
Easy: Save an amount equal to 30% of gross income, minus the amount you are paying towards a mortgage or rent, minus extraordinary short-term expenses like daycare costs.
The rule aims to strike a better balance between competing financial priorities. It also makes it easier to decide how much to set aside each year, and is more realistic and achievable than saving a flat percentage of pay, especially during the expensive childcare years.
This is all about consumption smoothing – not depriving oneself of a standard of living during the years of juggling competing financial goals. It backloads the high savings rate to later years when childcare expenses are long gone and the mortgage or rent payments make up a much smaller percentage of your gross income.
I love it! This brilliant yet simple rule is exactly what young Canadians need who are financially tapped out and feeling like they're falling behind. They can't do it all, so why strive to save 10-15% of your income for retirement while you live paycheque to paycheque?
Mr. Vettese says to follow the rule of 30 until you're within 10 years of retirement. At that point, take stock of your retirement-readiness and adjust your savings percentage accordingly.
For the record, most people still cling to the arbitrary 10% savings rule.
What percentage of pre-tax income should young parents (early 30s) save for retirement?
— Boomer and Echo (@BoomerandEcho) September 30, 2021
What I like about the rule of 30 is that it acknowledges the fact that life is hard for young families. Saving too much at an early age can have negative consequences for your enjoyment of life. The rule of 30 gives young savers a break, but offers clear guidelines about how much to save when short-term extraordinary expenses ease up and income increases.
Again, the rule of 30 involves saving 30% a year for retirement, minus mortgage payments or rent, and minus extraordinary short-term, necessary expenses like daycare.
It's essentially a way to save until age 55, at which point a more precise calculation can be made for your required savings rate with help from a retirement calculator (or a fee-only financial planner).
Let's see the rule of 30 in action.
Fake clients of mine named Ronnie and Lisa have a combined gross income of $166,666. The rule of 30 says they should save $50,000 (30%), less mortgage payments and childcare costs.
Their mortgage costs $2,300 per month, or $27,600 per year. They also have daycare expenses of $1,200 per month, or $14,400 per year.
This leaves Ronnie and Lisa with $8,000 per year to save for retirement. Astute readers will note that is just 4.8% of their gross income.
But the childcare costs won't last forever. In five years those costs will be reduced to zero. At that time, with 2% annual salary increases, Ronnie and Lisa now earn a combined $184,000 per year. The rule of 30 says they should save $55,200 (30%), less mortgage payments and other extraordinary costs.
Their mortgage costs are still $2,300 per month, or $27,600 per year. They don't have any other extraordinary costs.
This leaves Ronnie and Lisa with $27,600 per year to save for retirement. That's now 15% of their gross income. Fantastic!
Ronnie and Lisa follow this path, increasing their savings rate as their income rises until eventually their mortgage is fully paid off. Let's say they're now earning a combined $225,000 gross income. The rule of 30 says they should save a whopping $67,500 for retirement (30%). And they can do this because their mortgage is paid off.
The beauty of the rule of 30 is all along the way Ronnie and Lisa can maintain a fairly smooth spending rate. There's no period in which they are suffering financially. They give themselves a break on saving for retirement during their expensive childcare years, when the mortgage also makes up a larger percentage of their gross income and take-home pay. Then they ramp up their savings as their income increases and extraordinary costs disappear.
Dangers of The Rule of 30
Mr. Vettese acknowledges the dangers of this variable approach to saving for retirement. What else can be classified as an extraordinary short-term expense? A car loan? A home renovation loan? The author says there will always be expenses that fall into a grey area, and whether to include them as an offset to retirement savings is entirely up to you. But there's no incentive for you to ‘game' the system since you're only cheating yourself at the end of the day.
Another danger is the risk of job loss or health issues that prevent you from earning income in your later years. If you've backloaded savings too much then there's a good chance you won't be prepared for retirement.
Mr. Vettese suggests paying off your mortgage five years before retirement (staying within the rule of 30, that would mean increasing the mortgage payments and reducing your savings rate). He also suggests discounting your projected income in your final working years by about 30% to hedge against one spouse losing their job.
Other Retirement Savings Enhancements
Besides saving 30% of gross pay, minus mortgage or rent, minus extraordinary short-term expenses, Mr. Vettese offers plenty of other insights in The Rule of 30.
He suggests investing in stocks and bonds instead of real estate. While buying condos or other real estate properties and renting them out has been a popular alternative to investing, Mr. Vettese says that as long as you have contribution room in an RRSP or TFSA, the use of tax-assisted investment vehicles is a better bet.
He also says to use a target-date-fund approach to set your asset mix, rather than using a static 60/40 balanced portfolio throughout your entire investing lifetime. That means starting with a high equity weighting (up to 100%) in your portfolio when you're young, and then gradually increasing the bond weighting to an “ultimate-mix” of 50/50 just before retirement. Mr. Vettese says this approach has been more effective than a 60/40 asset mix over 30-year periods.
How Much To Save For Retirement?
I laughed when I read the opening chapter about how much you should save. Mr. Vettese was scouring books and the internet to find a source promoting a specific savings rate. None could be found. Then he wrote this:
My last find was an online article by Global News, which reported that “you may have heard you should be saving 10-15 percent of your pre-tax income”. This was tantalizing, since I wasn't sure I had heard that, though it did sound vaguely familiar. Alas, this little nugget turned out to be little more than hearsay. The article didn't cite the source of this 10-15 percent range or attempt to confirm that it is indeed correct. It smacked of urban legend.
The reason I laughed is because this article sounded familiar to me and indeed I was interviewed for it by Global's Erica Alini. Hey, I made it into the book – sort of!
Mr. Vettese attempts to offer an answer to the question of how much to save for retirement with the rule of 30. He acknowledges that in reality, no one percentage can be certain to carry most savers across the finish line safely without causing undue hardship along the way.
He says if he absolutely had to provide a one-size-fits-all flat percentage of pay, he would make it 12% with the caveat that you might have to change that percentage as you get closer to retirement. Expressed differently, he would suggest saving 5% of income in your 30s, 15% in your 40s, and 25% in your 50s. This alternative represents a rough approximation of the rule of 30 (and lines up neatly with my Ronnie and Lisa example above).
Time For a Giveaway!
The Rule of 30 is a brand new book (released today!) by retirement expert and former chief actuary Fred Vettese. It offers an absolutely brilliant solution to the burning question of how much to save for retirement throughout your working years.
In addition to the rule of 30 and other retirement savings insights, Mr. Vettese shares his insightful wisdom about why the future will be different with a look at inflation, wage increases, interest rates, expected returns for bonds, and the wildly unpredictable stock market.
In short, this is book is an absolute game-changer for young Canadians and offers a fresh perspective on saving and investing for retirement. If young Canadians read only one book about personal finance, make sure it's The Rule of 30.
I was fortunate enough to receive an early edition of The Rule of 30, plus an extra copy to giveaway to a lucky reader. You can enter to win that copy by leaving a comment below sharing your current savings rate (if you're in the accumulating years) or past savings rate (if you're already retired). Or, feel free to leave any comment in general about the rule of 30.
This contest will be open until Friday October 22nd at 8 p.m. EST. I'll announce the winner in the next edition of Weekend Reading.
Good luck!
