How much money will you need to save in retirement? Think you’ll need $2 million? You may be surprised, but according to a recent article on MSN, experts believe that $2M should be the new goal for most Gen Y’ers. In fact, they also suggest that Gen X’ers strive for a $2M nest egg as well.
Although I appreciate articles of this nature and understand that their intended purpose is to reach a broad general interest audience, there were a few things that raised a red flag:
1) $2M may be way more than some people will ever need.
2) The $2M goal is based on working until you reach age 70. Who wants to do that? What if your timeline is compressed so that you can retire earlier?
Using conventional wisdom, a $2M portfolio with a 4% withdrawal rate would give you $80,000 of income each year (excluding taxes). Sounds pretty good, but do you make this much now?
It’s not that hard to figure out how much income you’ll need in retirement (see my previous post on how to do this). All things considered, many experts believe you’ll only need about 80% of your current income to continue your same standard of living into retirement. So really that $80,000 figure applies if you’re making $100,000 each year right now! Making a little less than that? Then read on….
Defining Retirement:
First of all, don’t think of retirement as all blue hair and bingo. We’re going to define retirement as when you’re “financially able to stop working”. Really you could retire anytime you want … as long as you can afford it.
Don’t Underestimate Psychology:
If I told you to save $2 million dollars, you’d probably freak out. But if I told you to save $7,149 every year (about $600 every month) for 40 years, that might sound a little more realistic. Well guess what? They’re the same thing (the future value of $7,149 compounded annually by 8% for 40 years = $2,000,000).
* Read my post on how to calculate compound interest.
Do you see how one sounds better than the other? People are emotional beings. Don’t underestimate the power of psychology when it comes to saving.
Crunching the Numbers:
So although it helps to have a single goal like saying “save $2 million dollars”, there would be a lot of benefit to taking it a step further in terms of 1) time and 2) how much you need to save each year.
Let’s suppose you’ve read my past post on how to calculate how much you’ll need for retirement each year and you have a number in mind. Below is a graph that shows how much you’d need to save each year versus how many years you’ve got until retirement. Just pick which curved line best represents how much you’ll need in retirement each year, follow it to how many years you’ve got until retirement (horizontal axis), and then look over to the left to see how much you’ll need to save (vertical axis).
Since portions of this graph are simply ridiculous (like trying to put aside $2.4M with 1 year to go before retirement), I have also included the same exact graph below which has been zoomed in on the sections that are relevant to you.
As you can see, there are an infinite number of combinations for achieving your retirement income goals. For example:
• If you could retire off of $20,000 per year (blue line), you could save $36K per year and retire in 10 years, or you could save $6K per year and retire in 30 years.
• If you could retire off of $60,000 per year (yellow line), you could save $46K per year and retire in 18 years, or you could save $12K per year and retire in 36 years.
• If you expect to retire off of $100,000 per year (dark purple line), you could save $64K per year and retire in 20 years, or you could save $15K per year and retire in 40 years.
• Etc, etc.
If you think that an 8% annual return is probably too optimistic, here is the same graph again (zoomed in) and calculated using a 6% annual return.
Summary:
Rather than focus on the BIG number, try to get a feel for 1) how long you want to save and 2) how much you’ll need to save each year. Doing so will not only give you more realistic goals to hit, but will also put you in a better position for planning what lies ahead.
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