When can I retire?
I can retire if I have enough money to live off until I die. Easy enough. But how much money is that? What is the magic number?
Needless to say, the number varies from person to person: how big my nest egg should be, largely depends on my planned lifestyle once I retire, how much I am earning now and on how I invest.
And of course, how long I will live.
How much will I spend when I retire?
It is generally safe to assume that when I retire I will have less of some expenses, and more of others: I may no longer have school fees to pay (if my children have finished school and started working) or mortgage payments to make, but I may have to budget for higher health-related costs.
As I explore how much money I might really need in retirement, I need to take into account that the amount I decide to save and invest on my own is possibly only one component of my future retirement income as I may have income sources that I can count on regardless, like a national, corporate or private pension plan.
Most advisers suggest 80% of my annual income is a good starting point to determine my actual income needs, which then need to be revised based on personal factors (if my health is shaky or if I want to travel extensively upon retirement, I may well need more than 80%).
Of course, there is inflation to consider. All else being equal, every year my income needs at retirement will increase by at least the rate of inflation (I will need more because what I spend money on costs more).
So, how to calculate my retirement savings?
There are several ways to come up with a number estimate. And one of the most common ones is the so-called “4% rule”.
The 4% rule suggests that my retirement savings need to be equal to my target retirement income divided by 4%, which translates into the ability to withdraw (i.e. spend) 4% of my savings in the first year of retirement and increase the annual withdrawals by the rate of inflation. This rule is attributed to William Bengen, a financial adviser who came up with it in the mid-1990s. Studying historical data on stock and bond returns between 1926 and 1976, Bengen observed that a 4% annual (inflation-adjusted) withdrawal never exhausted a retirement portfolio (with evenly-balanced equity and government bonds allocations) in less than 33 years (or 41, adjusting the rate to 3%).
While the 4% rule offers a clear advantage in its simplicity, it really is only a rule of thumb. How my retirement savings are invested is a key factor to consider, as very aggressive portfolios may well erode enough in value during turbulent times to invalidate the rule. Or I may “live too long”. Or I may have unexpected expenses, beyond my “allowed” annual withdrawal limit. And if the current inflationary environment were to continue for a long time, this 4% might not be enough if your investments are not growing on par with inflation.
How much do I need to save?
Other techniques to identify the magic number avoid the actual number all together, focussing instead on much I need to save every year (Fidelity suggests 15% of gross salary, every year) or how much I need to have saved, by age brackets:
|30||1x annual salary|
|40||3x annual salary|
|50||6x annual salary|
|60||8x annual salary|
|67||10x annual salary|
Of course, this is a gross simplification because it does not take into account one’s specific case of a salary and a lifestyle much higher/lower than the average.
Whichever method I decide to follow, it is hard to imagine being able to stick with a retirement plan year in and year out. While sometimes I will be able to save more and sometimes less, it’s important to stay as close to the target as possible and – equally important – to check the progress. Wealth tracking is absolutely crucial if I want to make sure I know where I stand vis-a-vis my retirement plan, or else it will be like driving a car at night with the lights off: I may be in for a nasty surprise.
Exirio gives you exactly that, a powerful tool to track your wealth that not only aggregates all your investments in one place, but gives you the full performance history and return metrics of all your investments. And – you guessed it – a cutting-edge retirement planner is in the making – watch this space! In the meantime, you can find dozens of complex spreadsheets on Internet forums related to personal finance and the FIRE movement.
Managing money in (early) retirement
So, I have saved following the various pundits’ predicaments and today is my first day of retirement. How do I manage my savings and how do I withdraw the cash I need to live?
One popular approach is the Bucket Strategy, whereby I split my wealth into three buckets. The first has enough cash to cover 6 to 24 months of living expenses, the second to cover 5 years (and it’s invested in relatively safe liquid investments like government bonds) and the third bucket is allocated to equities. The idea behind the Bucket Strategy is to prevent panic selling when the equity markets are down, by essentially always having enough cash available to weather the storm without selling equities. While it may sound simple, it’s an approach that is silent on asset allocation and how/when to re-balance the buckets. One simple way to tackle the asset allocation point is to selectively choose what portion of the retirement portfolio to sell to fund the ongoing living expenses. If the equity markets are down, my 4% annual spending will be funded by selling bonds rather than stocks, which in turn will rebalance my portfolio towards equities.
When we say “retire”, we mean financial freedom: the ability to do what I want to do with my time, i.e. not having to do what, be where, or wear what someone else tells me to. Or in the words of Naval Ravikant: “I don’t care how rich you are. I don’t care whether you’re a top Wall Street banker, if somebody has to tell you when to be at work, what to wear and how to behave, you’re not a free person. You’re not actually rich.”
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