This is a guest post from J.D. Roth, who founded the blog Get Rich Slowly in 2006. Roth wrote Your Money: The Missing Manual and is the "Your Money" columnist for Entrepreneur magazine. His latest project is a year-long course on how to master your money, which explains how to slash costs and boost income so that you can pursue early retirement and other goals. This article is one piece of this course.
As Chief Financial Officer, one of the toughest challenges you face when planning for the future is knowing how much to save for retirement. If you save too little, you could find yourself working at Wal-Mart during retirement or living with your son-in-law. Save too much, though, and you'll sacrifice some of the good life you could be enjoying today.
Traditionally, financial planners and retirement calculators have suggested you'll need 70 percent (or 80 percent or 100 percent) of your pre-retirement income to maintain your current lifestyle when you've finished working. But this doesn't make any sense. Assume You, Inc. earns $80,000 per year. Standard retirement advice says you'll need $56,000 per year (70% of $80,000) in order to retire. But what if You, Inc. spends (and continues to spend) $70,000 per year? Following traditional advice, you won't have saved enough. And if You, Inc. spends a thrifty $20,000 per year? Well, then you'll have oversaved, which means you could have used some of that money to enjoy life more when you were younger.
There's no doubt that you'll need a sizable nest egg for retirement especially if you plan to travel or play golf every day but don't be fooled by the constant refrain that you need to save 70 percent of your retirement income to retire well. That's no way to prepare for the future.
How much should you save? Begin by looking at how much You, Inc. spends each month. According to the 2010 Retirement Confidence Survey from the Employee Benefit Research Institute:
- Nearly half of retirees spend less in retirement than before (23% spend much less).
- Roughly 37% spend the same in retirement as they did when they were working.
- Only 13% of people spend more in retirement than before -- and of these, six percent say their expenses are only "a little higher".
In other words, your pre-retirement expenses are good indicator of how much you'll spend when you've finished working. Take some time now to run the numbers for You, Inc. At a minimum, compute the following:
- How much do you spend? Review recent income statements. On average, how much does You, Inc. spend each month? (Don't include retirement contributions or business expenses.
- How much do you save? On average, how much profit does You, Inc. earn each month? (Again, you'll find this on your income statement.)
- How much have you saved? For the sake of simplicity, you could use your net worth. If you'd prefer, remove the value of your home from the equation, which will yield the total of your liquid savings.
Once you know how much You, Inc. spends, it's easy to calculate how much you'll need to save for retirement. All such estimates are based on some basic assumptions about inflation, investment returns, and your lifespan. These arguments and calculations can be simplified to the following statements:
- If you have a high tolerance for risk and make some bold assumptions, you might decide to retire when you've saved enough to cover 20 years of expenses.
- If you're more cautious, you might wait to retire You, Inc. has enough in the bank to cover 30 years of spending.
- Most people should aim to retire when they've saved enough to fund 25 years of expenses, it's probably safe to quit your job.
This is why it's so important to keep control of your monthly spending. For every dollar you spend per month, you need to save between $240 and $360 in order to retire. If you spend $1000 per month, you'll need to have a nest egg of between $240,000 and $360,000. If you spend $5000 per month, you'll need between $1.2 million and $1.8 million in the bank.
If you want more info, go online to explore the dozens of retirement calculators scattered across the web, each of which is a little different. No one calculator is necessarily better than any other, but I've found the following handy while planning for the future of JD, Inc.:
- The Motley Fool has two useful calculators, one that estimates your retirement expenses and one that lets you see if you're saving enough.
- Bankrate's retirement calculator bases its results solely on your savings. Moneychimp has a similar, but simpler, calculator.
- Choose to Save has a ballpark estimate tool that can be used online or off (or on your smartphone). It's the best of the calculators that use income instead of expenses.
For a great combination of simplicity and complexity, check out FireCalc.com. Although the site can seem overwhelming, its method is fairly elegant. It gives you an idea of how safe your retirement plan is based on how it would have withstood every market condition we've faced since 1871.
By plugging your numbers into several calculators, you can get a better feel for how much you'll really need in retirement. But don't just play with the numbers. Talk with the people you know. Chances are they'll tell you to save. But if the Retirement Confidence Survey is any indication, they'll also tell you that things aren't as bad as you'd think.
Determining how much to save for retirement is actually one of the key tasks you face as Chief Financial Officer. Some would argue it's the most important calculation you'll perform, and that everything else you do for You, Inc. is in support of this.
This is a modified excerpt from "Be Your Own CFO", the 120-page guide included with the year-long "Get Rich Slowly" course. The guide includes tips for boosting revenue and cutting costs so that you can maximize profit in order to achieve your dreams, whether those are to retire early, send your kids to college, or travel the world. Want to know more? Buy it now.