[Author's Note: This article is not an offering of investment advice nor is it a guarantee of investment returns. It is merely a representation of how I choose to plan for and invest my personal retirement savings. Any assumptions or numbers used are for illustration purposes only and are not to be construed as investment advice.]
As part of my financial overhaul in 2014, which happens to be the year I turned 40, I am taking a hard look at planning and saving for retirement. Planning involves thinking about when I want to retire, my philosophy for the lifestyle I want when I retire, and how much money I will need in retirement. Saving for retirement involves which investment vehicles I will use, my overall investment strategy, and a disciplined commitment to stick to the plan.
WHEN SHOULD I RETIRE?
Picking the day you will stop working decades before it will happen seems unrealistic to me. I would rather answer this question: at what age would I like to be financially able to retire? Many people are working into their late sixties and even seventies. Some do this because they have to, others because they want to. My goal is to be financially able to no longer need to earn an income at 60-years-old. I believe I will want to keep working beyond that point, primarily because I really enjoy a lot of things about work and because I like to have things to do. I don't "hang-out" well.
One of the main reasons to pick 60-years-old is because my wife and I have a goal to serve a mission together. We have actually set a date to accomplish this, hoping to leave about February of 2034. That is one month before I turn 60. And it would be nice if the pressure to provide an income was gone, allowing me an unrestricted focus to do what I love, focused on where and how I can have the most impact for good.
HOW MUCH MONEY WILL I NEED TO RETIRE?
There are so many variables that go into knowing how much I will need when I retire, like:
- How long will I live?
- How long will my wife live?
- What financial needs will my children have post-college that I should help with?
- How much will I really want to spoil my grandchildren?
- Will my health allow me to travel and do other adventurous things that cost money?
- Will my health land in me in an expensive long-term care home?
- Will I even live to see retirement?
- Will Social Security still be available?
- What tax bracket will I be in? What will be the state of our taxation system?
- What will inflation be?
- What return will my retirement investments earn?
Financial planners use a complicated, assumption-based model to print out pages and pages of details to show you how much you need to set aside for retirement. I respect the work these professionals do, but I know that the plans they create are only as valid as the assumptions they make, which are certain to be wrong on several fronts.
PICK THE NUMBER!
So here is my simple approach. I assumed I would need to live on $50,000/year, or about $4,000/month (not including social security or anything else, just what I plan to contribute to my retirement). I hope I live until I am 100. Knowing that I want to be financially prepared for retirement at age 60, that means I need 40 years worth of $50,000/year. That totals $2,000,000. That's a lot of money. But it would only support a modest lifestyle until age 100, based on my calculation in today's dollars.
$2,000,000 is a HUGE number, yet it is very achievable with time and the right investment strategy and vehicles, not to mention a tremendous amount of discipline to make it happen. Could I retire on a lot less than that? Considering investment returns minus inflation, probably. In the spirit of simplicity, I am excluding the tax, inflation, and investment return assumptions so I can pick a number. When I hit the number, I know I can be done with worrying about having enough. And regardless of what unforeseen things happen, I know that I can make it through retirement with that. If I never reach the number, I'll know I likely need to earn money longer or hope that social security is still around to help supplement what I have.
HOW MUCH DO I NEED TO SAVE TO HIT MY NUMBER?
To keep some confidentiality, I am not going to give you specifics about my situation from here forward. I have been saving for retirement since the very first job I had while I was in college. So, I am not starting with zero. I have actually done okay, primarily because some of the money has been invested for almost 20 years. That's a lot of time to grow. Starting as early as possible is often the most critical part of reaching retirement savings goals!
To figure out how much I need to save, I first need to figure out how much of the $2,000,000 I don't need to save. I start by using the Rule of 72 to determine how much my current retirement savings will become over the next 20 years when I turn 60. Simply, this rule states that I take my expected return on my investments, divide it into 72, and that is the number of years it will take for my money to double. If I assume an annual rate of return of 9%, 72 divided by 9 equals 8. That means my investment will double every 8 years.
If I have $150,000 saved for retirement today, then based on the rule of 72 and my assumed rate of return it should double to $300,000 in 8 years. Then it will double again to $600,000 in another 8 years. The, with only 4 years left until age 60, it will increase 50%, or to a total balance of $900,000 when I turn 60.
Of course most investments do not move in a perfectly linear path like this, but over time the final outcome should be in the ballpark. So, of my $2 million goal in 20 years, almost half is taken care of, leaving me with a need to figure out how to save and get that savings to grow to $1.1 million in 20 years.
Assuming no rate of growth, I would have to save $55,000 per year for the next 20 years to have a balance of $1.1 million. I don't know about you, but I do not have that much "discretionary" income every year to set aside. I have 7 kids, braces, house payment, and lots of other things that spread my budget pretty thin. So what happens if I consider the potential growth of 9% on all of the money I invest between now and retirement? How much would I have to put in then? Turns out I can cut the number more than in half.
Using a simple excel spreadsheet formula called PMT, I determine how much I would need to set aside each year to end up with $1.1 million in 20 years. I may need to write a separate blog post about how to use Excel to do this if you are interested, but here is a picture of how it looks in Excel:
So I need to set aside $21,500 per year, or about $1,800 per month to hit my goal. That is still a lot of money. Remember, so far all of the numbers used have been for illustration. I have followed this process with my own numbers to determine the amount of money I need to save every month to shoot to be financially prepared for retirement at age 60. Will it work out perfectly? No, but it should get me into the ballpark of where I need to be.
Here is the main key for retirement savings - use low cost, tax deferred retirement accounts as much as possible. Tax deferred means that your earnings every year are not taxed. This includes Roth and Traditional IRAs, 401(k), 403(b), and other employer sponsored plans. I currently use my employer's 401(k) to defer 5% of my income into my account, and they match another 4%. Then I use a Roth IRA for myself and my wife to handle the rest. You will want to consult a tax expert to help you decide which vehicles are the best for you.
As I mentioned in another post about my 401(k) investment strategy, I am comfortable with quite a bit of risk exposure for my retirement funds, primarily because of the long time horizon - 20 years. As retirement gets closer, I will need to become a little more risk averse, although not so conservative that inflation erodes my hard-earned and saved principal.
I have invested my 401(k) into all stock mutual funds representing a broadly diversified and strategically allocated portfolio. My Roth IRA is also 100% in stocks, using a managed and balanced portfolio at Betterment.com. My wife's Roth IRA is slightly more conservative with a 90% stock 10% bond portfolio at Betterment. If you haven't learned about the Betterment philosophy and offering, I would encourage you to do so. It is the most aligned with my investment approach of any that I have found. You can get a $25 reward if you use this link to set-up an account: Betterment $25 Referral Reward.
DISCIPLINE & REGULAR REVIEWS
With the right strategy, investment vehicles, and dollar amount in place, it is time to make it happen. I have a lot that I want to accomplish with my life once I turn 60, and I do not want money to hold me back. I want it to be a tool to enable my wife and I to enjoy our lives and accomplish much. I am, therefore, willing to make sacrifices today to make it happen. It requires discipline to set some "wants" aside and save the money for the future. It also requires regular reviews to re-work the numbers and make adjustments and changes as necessary.
Will it work out perfectly? Of course not. I may need to work longer if the market doesn't do as well as hoped or if I am unable to save enough money. I am, however, confident that my proactive approach will produce far greater results than a reactive, unplanned approach.
Start as early in life as possible. Pick a number. Select the right investment vehicles and strategies to make it happen. Execute. Review regularly, pivot, tweak, and re-commit. That's my retirement savings plan. What's yours?