How Much Money Do You Need To Retire?
One of the most common questions we receive from clients is ‘how much money do you actually need to retire?’ The answer, like most things in life, greatly depends.
The two most important things to factor in are:
1) how much will you spend and
2) how much will you have saved
There are some good ways to think about preparing for retirement today with these two questions in focus.
Focus First On How Much You Will Spend
The first step to answering the retirement question is starting with spending. Obviously, someone that spends $1 million per year will need to save more money than someone who spends $10,000 per year.
Start with how much you currently spend. Analyze your bank account and credit card statements from the past six months and put the expense categories in a simple spreadsheet. What is your average spend per month? Are there parts of your budget that will drop off in retirement (for example, home mortgage)? Are there parts of your budget that will increase during retirement (for example, medical spending)?
Once you have a solid estimate of your current monthly spending, grow that number by the rate of inflation (typically around 3%). If you think you will retire in 10 years, then grow your current spending by the rate of inflation for 10 years. This inflated number is a good rough estimate for how much you will spend in retirement. (p.s. if you need help calculating the inflated number just google “inflation calculator” for some tools that can help)
The 4% Rule
Once you have a good idea of how much money you will spend, it’s possible to estimate the magic number you need to save with the “4% rule”. The 4% rule states that you won’t run out of money in retirement if you spend less than 4% of your total savings, as long as you have a solid investment portfolio.
To demonstrate with numbers, if you plan to spend $100,000 per year in retirement, the 4% rule implies you will need to save at least $2.5 million (calculated by dividing $100,000 by 4%).
It’s that simple! Figure out how much you plan to spend in retirement and then divide that number by 4% to arrive at your estimated retirement savings goal.
The Hard Part: Saving & Investing
Saving for retirement requires active effort. Everyone needs a plan for saving and needs a suitable investment strategy.
A well-balanced investment strategy will earn between 8% and 12% per year. If your investments appreciate at a faster rate, you will need to save less, or you may be able to retire earlier. Therefore, it makes sense to consider different investment alternatives, including options that could result in better performance.
However, don’t expect investment performance alone to fully fund a retirement. Steadily putting away savings is the foundation for any sound retirement plan.
Key Takeaways:
Financially preparing for retirement takes planning! Here's a quick recap:
Estimate spending needs: Calculate your current spending and then grow that number by inflation to get a rough estimate.
Use the 4% rule to calculate “the number”: What size will your portfolio need to be if you can only spend 4% per year and not eat into your principal?
Start saving and investing early: The earlier you start saving and investing, the more financial freedom you will have!