(… Depending on the answer, it might also make you feel really good about your savings efforts so far!)
Suppose you were suddenly let go from your job. You find a new place to work, but it doesn’t pay as well.
So in order to maintain your standard of living you decide you’re going to cut corners and completely STOP saving money for retirement.
The big question:
Would you still be able to comfortably retire when you want to?
My Answer …
(… Kind of a funny question to ask on a personal finance blog, right? …)
I tried this little experiment on our current retirement savings, and you want to know what I found out?
We’d be okay!!
It’s true. As many of you know my wife and I have a plan to retire in about 10 years from now. So when I added up our savings, calculated what they would potentially be in 10 years from now (using 10% returns with a 3% inflation adjustment), here’s what I came up with:
- Using a safe withdrawal rate of 4% = $4,446 per month
- Using an ever safer withdrawal rate of 3% = $3,334 per month
Combine either of those figures with the $2,051 we expect my wife’s pension to be, and we’ve successfully exceeded our anticipated cost of living need of $5,000 per month.
How Is This Possible?
I know what some of you are thinking – how can I STOP saving for retirement altogether and still meet our goals? Something doesn’t add up …
Fortunately it’s all thanks to the marvelous power of compounding returns. Because my wife and I have done a pretty good job of saving so much money, we’re now at a point where the earnings from our savings actually contributes more to our nest egg than what we’re saving each year.
Just see this image below:
This is an example of compounding returns in progress. Notice how around year 15 the red part starts to outgrow the blue part? That’s because after a while your money starts to “make more money” than you do!
The “red part” is where we are at in our phase of accumulation. Adding money to it every year will be nice and all, but the real magnitude of growth will come from the money that is already in there.
This is just another nod as to why it’s important to start saving early and save big (like I stress hardcore in my first ebook)!
The First Signs of Financial Freedom!
So why care about how much my retirement savings are going to be under these fictitious conditions? After all, it’s not like I’m really going to suddenly STOP saving money into our retirement nest egg.
Plus I’m still 10 years away from retirement …
So where does that get me?
The reason I did this little exercise is because in our quest for financial freedom I think there are little milestones that we need to recognize and appreciate. And this is one of them!
Not that long ago I did a similar exercise in this post here and was further away than I thought. Now, almost a year later, it turns out we’re getting closer!
In terms of being where we want to be financially, this is the equivalent of just starting to see the sun peaking out from behind the trees in anticipation of a grand sunrise!
Though I would still need to let my money compound for at least 10 more years to make this happen, what this tells me is that the assets we have built up right now are significant enough that they could mature into a fortune that would take care of us for life.
Call it what you will – I see that as a HUGE accomplishment!
It’s a big deal to me because it gives me a positive sense of confidence and security that I would otherwise be lacking.
Suppose I really did lose my job. Suppose I did take another job that only paid half of what I make now. If I really honestly and truly had to stop all future contributions to my retirement funds, it’s very pleasing to know that at this point the game it changes nothing in terms of money!
In other words: There’s no knocking us off the road we’re on!
What If You Stopped Saving Money for Retirement?
Now you try!
- Enter the current value of all your savings accounts into a cell.
- In the next cell type in 7%. We’ll use 7% because that represents an average annualized return rate of 10% minus the average rate of inflation 3%.
- Next type in the number of years until you plan to retire.
- Calculate the future value of your assets. In Excel the formula is =-FV(cell with return rate, cell with number of years, 0, cell with current value of your savings account)
- Finally multiply the future value of your assets by 0.04 and divide it by 12 to get your estimated monthly retirement income (assuming a 4% withdrawal rate). If you really want to play it safe with your withdrawal rate to lower the potential that you could run out of money, use 0.03 to represent a 3% withdrawal rate.
Do you like what you see?
The important lesson to take away from here is just how powerful compounding returns are, and why we need to save/invest as soon as possible rather than waiting to do so in the future.
Because of how much money we have saved up so far, that’s why we could theoretically STOP all our retirement savings and continue to be okay. The compounded returns from just the assets we have so far we would potentially be enough to carry forward and amass into a fortune that we could use to live on.
That’s not an accident! That’s by design. About 5 years ago my wife and I made a conscious choice that we wanted to retire sooner than later. To do so we decided to up our retirement savings from a meager 10% of our income all the way up to the point where we are maxing out all of our retirement accounts.
It wasn’t easy. Sacrifices had to be made. But after careful planning we got there. And now I’m proud to prove to myself that the mass we’ve built up so far could potentially grow into the fortune we need to secure our financial freedom.
Readers – How did you do at this test? Could you stop saving today and still be on track? How do you challenge yourself at saving money for retirement?
Image courtesy of Neil Fowler | Flickr