Whether you want to retire as early as possible or are happy to work into old age, the question of when you are financially able to retire often seems to be based on a theoretical number.
But how much do you actually need in reality?
Search the subject online and you’ll see that among the various calculators, theories, ‘magic numbers’ and rules of thumb listed in the search returns, the ideas about what retirement savings should look like vary quite substantially.
I know, I know – you just want a number you can work towards and hopefully achieve, but here’s the truth of the matter: it’s not always that simple – and I say that as someone with some experience in personal finance (no, this post does not constitute advice), because it really is difficult to come up with a definitive number.
Yes, you can come up with a number.
That in itself is not difficult.
There are various ways to do this, the simplest and most common being the 4% rule, which uses an income of 4% of your total savings as a safe withdrawal rate to last indefinitely. Therefore, if you estimate that you need, say, $40,000 per year to live, you can just divide $40,000 by 4% and it gives you a figure of $1,000,000, which is the principal amount you would need to have invested to take a 4% withdrawal every year without running out of money.
Another common rule of thumb is to have 10 times your salary saved – if you are retiring at 67 years old.
Half to two-thirds of your current salary is another often-quoted rule of thumb.
So, you can reach a number to target, but, of course, whether that number is actually of any use is another thing, because it really depends on how you invest that money and your real expenditure during retirement.
For that reason, some people can (and do) retire with way less than $500,000 and others need more than $2 million to fund their lifestyle. Some people might not even earn $1 million in a lifetime, so building a pot of $2 million would be a tall order, although not completely impossible.
The other thing is, people want to know the minimum amount they need to save or invest in order to retire.
You see, when it comes to planning your finances, it is no different to planning most other aspects of your life – there are many known and unknown variables to consider.
Remember that financial planning is a process – it’s not a product.
And the process is one that needs to be adapted and reviewed regularly according not only to your current financial situation, but also to what you know is going to happen in the future (e.g. your kids will be starting college in 5 years’ time), what you think could happen in the future (e.g. a promotion, a change of location) and also make contingencies for the unplanned events, i.e. the ones that you don’t know will happen in the future, which are not always bad things like divorce or death, but could include unexpected windfalls or career opportunities. In any case, assumptions need to be made and broad ranges set.
How much you need to retire depends, but for want of a definitive number, save as much as you can whenever you can.
So, in a lot of ways, it is not really about saying, “I need to save 10% of my monthly income every month”, or whatever. Sometimes, you might not have 10% left. Other times you might have 50%. But saving as much as you can, whenever you can is the real rule for saving.
How to actually invest that money and how much you can draw down in retirement is a whole other matter.
You might want to invest everything in the stock market or maybe buy property to ensure a regular income stream. Both come with risks and you are probably best to diversify, but that is a personal choice.
And there are these variables you have to play with:
- Save more now and retire earlier
- Save more now and be more comfortable in retirement
- Save less and have a less comfortable in retirement
- Save less and retire later or keep working in retirement
The world has changed in that more and more people are working beyond the standard retirement age, either through choice or necessity, but there is a difference between wanting to work and having to work.
There are also many more ways of earning money from home these days – blogging, affiliate marketing and all number of other side hustles that can be done from home.
When you do decide to stop doing any form of paid work, however, managing your retirement income stream (or streams) is a different ball game, since you are generally dealing with finite amounts without the luxury of new money coming into play from employment.
You can often make a choice about whether you save or spend, but when you are retired and effectively no longer earning a regular income, a lot of options are taken off the table – the pot you have is what you have to work with, from which to create an income.
A simplistic way to look at things is to start with an imaginary scenario today, where you have no mortgage and no dependents to support and ask yourself (but again, just because you have taken retirement does not always mean you have no mortgage and no dependents), how much monthly income would I need for a comfortable life today?
By answering a few questions and by making certain assumptions, we can get to some kind of figure, but we’re still just guessing really!
- How much annual income do you need or want in retirement?
- What is your projected total savings amount between now and your target retirement date?
- How many years are you expected to live after retirement?
- What rate of return will your investments earn before retirement?
- What rate of return will your investments earn during retirement?
- What is the expected rate of inflation going forward?
- What is your expected Social Security and pension income?
You also need to make certain assumptions about inflation rates and investment returns before and during retirement, life expectancy and health.
Then you need to factor in numbers for desired monthly income and projected expenditure and we can come up with a number. However, over-spending, under-investing, below-expected returns, forced early retirement, medical bills and other unforeseen expenditure can all distort the numbers.
And that is why you need to constantly review, so I return to my statement earlier: financial planning is a process, not a product.
Find a good adviser that you trust to help you come up with a strategy that suits you and then review your position regularly.
By all means, have a number to target if it helps you to save, but understand that there is more to it than simply hitting a number. And beware of personal finance bloggers who tell you with such certainty how much you should be saving and how much you need.