1/14/2014 4:30 PM ET|
Retirement planning with 3 numbers
Retirement math can be enough to drive anyone a little batty. If you've got handle on these 3 factors, though, you're off to a good start.
Professionals love complications. Trust me. I’m a lawyer. I know. We love using fancy words and really long sentences. Uttering something in Latin is even better. “Nunc pro tunc” is my personal favorite because it makes me feel like a time traveler.
Retirement planning should not be so complicated. We can put away the Monte Carlo simulators and fancy calculators. We don’t need a thick, smartly bound plan from a financial adviser. In fact, all we really need to understand are the following three numbers.
How big of a nest egg do you need for retirement? While that may seem like a complicated question, it’s not. Take your anticipated annual expenses during retirement (some use their current income as a proxy), subtract your expected Social Security and pension benefits and then multiply by 25.
For example, let’s assume you’ll need $75,000 a year in retirement and you’ll receive $25,000 a year in Social Security and pension benefits. Your nest egg needs to be $1.25 million ($50,000 x 25).
The logic behind the number 25 is simple. It assumes that a retiree can withdraw 4 percent of his or her investments each year without substantial risk of running out of money. Did you see what I did there? I snuck in the word “substantial” just before “risk.” Yes, it’s a lawyer trick designed to give us an out. But it’s important. There are no guarantees here. But a 4 percent withdraw rate is a safe bet, according to the experts.
Saving 25 times your annual expenses is a big number. If you are decades from retirement, it’s fair to ask just how much you need to save to meet this goal. The answer depends on how fast you want to get there. However, as a general rule of thumb, saving 15 percent of your income should get the job done.
If you start much later in life, you’ll need to save much more. If you want to retire early, you may need to save a lot more than 15 percent. A good resource to see exactly where you stand is called "Your Money Ratios." Written by Charles Farrell, this book will give you a good idea if you are on the right track given your age, income and retirement savings.
We need to have an estimate of the returns we can expect to receive on our investments. I use 8 percent for planning purposes. So you are probably wondering why the third number isn’t eight. Here’s why:
In order to earn 8 percent on average, it’s critical to have the right mix of investments. Play it too “safe” with lots of fixed-income securities, and it’s less likely that you can meet your retirement savings goals. On the other hand, putting everything into emerging market debt is likely to give even the most aggressive investor motion sickness.
As a good rule of thumb, you can use your age to devise a solid investment plan. Simply subtract your age from 100 and invest that percentage of your assets in equities, with the rest in bonds. For example, at 20 you would invest 80 percent in stocks and 20 percent in bonds. At age 50 it would be an even split. Some investors get a bit more aggressive and subtract their age from 120 instead of 100. That tilts the scale in favor of more equities, but is still a good rule of thumb.
Whatever choices you make, just remember that starting early is the "sine qua non", or essential ingredient, of a worry-free retirement.
More from U.S. News & World Report:
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I have read the save a Million dollars all my life and have saved 10% of my pay since the day I started working full time. I will have about 600.000 in 401k and I am sure I will be just fine. My Mother has been retired for 10 years now and had a max of $50,000 saved with house paid for. She has lived within her means and still has money available for emergencies. Great example.
The key is debt level and living within your means. Something most American and our Government do not understand..........................................
I see this 4% withdrawal amount a lot in these articles. They seem to assume your investments will not earn another dime during your retirement. There are many safe investments that can earn your
capital 4% or more during retirement, so your principle would never shrink just taking 4%.
The reality is you can draw a lot more than 4% of your nest egg and let the annual earnings replenish
a portion of what you draw each year.
Also most people after 85 will not be spending as much on recreational pursuits and travel.
So a wise plan would let you enjoy yourself more from 65 to 85 and winddown after that.
Unfortunately, young people don't take the time to think about what their lives will be like 60+ years down the road. And most don't have parents who care enough to try to guide them in their financial health. Most people will not invent something, like "Google", and become wealthy. If you have the chance, get educated first in a trade or profession that will pay a good salary over the long term. And educate yourself on savings strategies. Put as much as you can into growth stocks...as someone else said, think of yourself as a monthly "bill" that must be paid, just like your rent. If you are healthy enough, work at a second income-producing endeavor, and invest that money in stocks....good stocks, bought through a mutual fund, with low carrying costs. Stick to it, and over a 30 year working life you CAN have close to $1 million saved... which you need if you Don't have a defined benefit pension. If you CAN work somewhere with a defined benefit plan, (that will pay you a fixed amount every month in retirement), take the job and work to advance in it. Do the job you have to the best of your ability. Make good selections in a spouse, friends, and wait to have kids until you can better afford them (that is to say "NEVER"), and live frugally (don't trade cars every 2 years, or buy the latest jet ski, etc. and with luck, you can retire on your terms.
Oh and when people say it takes less to live in retirement than when you work...that may be true if you intend to stay in the house 24/7... but if you want to have a fulfilling life, you'll want to do a little traveling, go to the movies, golf or other hobbies...and that offsets any savings in not having to buy clothes for work, or gas to drive there everyday.
For myself, I was fortunate to have a father who pointed these things out to me as a little boy...so I kind of followed that lead, and retired from US government with a defined pension PLUS almost $800K in a 401K that I don't need to touch. And retired at 58 years old. It can be done, but the stars have to align somewhat.
Save 25 million before you retire? Right! When I started working at 13 for Farmers and the Minimum wage of the day 90 cents an hour. I know a lot of you are laughing about it but with 90 cents back than I could do more that you can with 3 hours of pay at $10 an hour or $30 today. Yes and in 45 years or so you will say what you made and the youngers will laugh at you I turn. A Burger, Fries and a Soda, 30 cents, a movie 25 cents and still have 30 cents left over to spend at the Concession Stand. That was only 1 hrs pay. Can you do that much with you $30?
I don't know who this person is writing about but if you make $25 thou a year, in 45 years you will make $1,250,000 and will be lucky to have $5,000 in the Bank when you retire. And, that is after Taxes. I honestly don't see how young people can afford to date now a days.
I grew up poor and my wife grew up slightly less poor. Our retirement is entirely from our own sweat. In fact, of all our friends, I can't think of any that haven't had substantial inheritence as a prime component in their retirement.
Reading a lot of disagreement about the $1.25 million calculation. Are you folks that are disagreeing making $75,000/year? That was the basis of the EXAMPLE. Unless watching paint peel is the highlight of ones retirement, I think the calculation is pretty close.
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Saving just a single month of expenses may take longer than you think. See how your savings rate affects how quickly you can build a solid emergency fund.
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