Saturday, December 8, 2012

How Much Will I Need To Be Able To #Retire?

So... you're thinking about retirement? 

At the risk of getting overly philosophical (which I plan to do later), maybe I should first ask what that means.  

Sometimes people say they just want to relax, and I respond by asking "how long will it be before you get bored?"  At other times people say they would like to travel, and I respond by asking "and what will you do when you get back?"

But, let's assume we're all saving for retirement - which is unconditionally a good idea - and the question is "how much do I need to save in order to retire?"  

I'm going to start by assuming that the Social Security net is broken, the system is bankrupt, and you have to be able to take care of yourself.

By way of an example, let's assume net (after tax) household income of $40,000 and monthly expenses of $3,000.  Out of the gate, applying simple math, we can deduce that spending $3,000 a month equals $36,000 which, in turn, leaves you able to save $4,000 (or 10% of net income).  Note two important points: (1) you must spend less than what you earn; and (2) you must save at least 10% of your net income. All good so far?

Now, the second critical step is to ensure that you have at least 12 months of living expenses in cash, in the event of a job loss, illness or other unexpected expense.  That means you already have $36,000 saved.  Still good?  If not, and you're reading this... you've already made progress!

Now... many smart financial advisors - people far smarter than me - suggest that your investment portfolio should include about 10-15% cash (or assets that can quickly be turned into cash, like stocks).

If $36,000 equals 10%, then 100% equals $360,000.  That's probably a good minimum savings target.  Minimum, because - when it comes to money - more is usually better!

But, $360,000 returning approximately 7% (see other, related postings on relatively safe, blue-chip investments) will return about $25,000 annually.  In reality, this means that if you're currently spending $3,000 (as per my example above), your will be required to cut your expenses by $1,000 a month.  This may be easy, because if you're not working, you may not need to shop for new clothes as often, pay for transport, buy lunch, etc.  Or, this may be difficult because you're already living a simple life (not shopping much, walking to work, making lunch at home, etc.).

The greatest ongoing cost for most people is rent or a mortgage, and you need a place to live in.  Can you downsize your living arrangements?  Perhaps the availability of some Social Security benefits (in the future) will add to your monthly income?  Could you relocate to a less expensive town/city/country?  Could you work part-time in retirement and call yourself semi-retired instead?

Back to the example above: In order to deliver about $36,000 an investor would need about $500,000 invested at 7%.  If you can generate a higher return, you can get away with less savings.  If you're going to invest in 'safe' securities, like bonds, you will need more savings.

Either way, it's never too late to start saving!  

Typical middle-class, salaried employees should NOT contemplate retirement with debt, or having to rely on government support.

If you are currently spending $3,000/month and you are in reach of that initial goal of $360,000 demonstrated above, you're well on your way to self-sufficiency in retirement.  

Don't rush to stop working and earning a living, and keep saving.  When you are ready to relax and enjoy the fruits of your labor... happy retirement!