Saturday, January 06, 2007

What is your savings goal for retirement?

I've been re-reading the last section of William Bernstein's The Four Pillars of Investing and glanced through his section discussing how much you needed to save for a 30 year retirement.

It, as usual, was quite interesting.

The simplest formula and one I've seen repeated elsewhere is to restrict withdrawels to 4% of your savings as of the start of your retirement. This comes from a study performed by professors at Trinity University. Basically, they measured the likeliness of retaining ones investment principal over a 25 year period based on various withdrawel rates. Here is a nice article discussing it.

It's very simple to apply this formula in reverse:

How much do you expect to spend every year while retired (and taxes to cover it) multiplied by 25.

That's it!

This approach does assume you'll have your money invested in a manner that provides the following:

a portfolio with an expected return that matches inflation plus 4%

In his analysis, Bernstein looked at a thirty year period starting in the 1960s during a very disfavourable bear market (the worst scenario for a retiree - as the money has less time to grow) and projected the returns for various combinations of equity and bonds. He found that combinations of no less than 50% equity were most likely to retain sufficient capital through the expected 30 year period. Obviously having some bonds reduces the portfolio volatility, which can be very important during retirement.

For the next 30 years, Bernstein projects the real return (after inflation) of the average domestic large cap investment to be 3.5%. This means retirees will need a diversified portfolio which might include value investments, small cap value, foreign investments and even emerging market investments - obviously the percentage of the riskier investments should be smaller.

It also implies the need for regular portfolio rebalancing in ones old age.

Here is my question for you: Who will rebalance your portfolio when you're 65? What about 75? or 90?

In my family's situation, we probably spend abour $12k per month. Actually right now it's higher, but I'm not including college savings, retirement savings, etc.... Our yearly then is about $144k. If we gross it up by 50% for various taxes it comes to $216,000 a year. Multiplied by 25 means we need to have $5,400,000 in today's dollars when we retire to live comfortable at 4% of our earnings with a 50/50 stock equity mix.

Honestly, that sounds like a hard number to make. We might be able to do it, but we should probably set our expenditures at lower levels for the following reasons:

  1. We will have paid off our mortgage
  2. No more college savings (unless we help with the grandkids - but we might save separately for that)
  3. No more saving for retirement
  4. Probably little if any life insurance premiums (we'll have assets to pass on and our dependents should no longer be dependent)
  5. Little if any need for disability insurance (we'll keep LTC and health insurance)
  6. Taxes may be lower due to cheaper state income tax (won't live in NC at 8.25%) and less income (maybe more as capital gains).

If we factor those reduced expenses into the equation, our monthly spending might be something close to $9,000 per month, though I'll settle at $10,000 to have funds to travel and spoil grandchildren with. $120,000 per year income multiplied grossed up by 40% (assuming greater tax efficiency) = $168,000. Multiplied by 25 = $4,200,000, which is pretty much my targetted retirement plan in Quicken's financial planner -- however, with much less work.

How much do you need for retirement? How are you estimating the amount?

Do you know if you're on track? How are you analyzing it?




Anonymous said...

Something doesn't seem right with your numbers. Spending $9k vs. $12k even with no mortgage, no retirement savings and no college savings. Is that right?? Are you really only spending $3000/mo on those items?

On a related note, $9000 still seems like a lot of money per month. Have you broken those expenses down into a detailed expense budget? I'm probably only looking at about 1/2 of that amount, but granted, I do not have kids (and thus won't have grand-kids :)

Anonymous said...

So actually you are planning on $10 million + in nominal dollars?

I'd consider $1million in today's money my lowest acceptable number. $2million in 2024 dollars when I am 60. Between myself and my girlfriend right now we spend around $45k a year (I spend $25k). If we have a child (we're agreed on not more than one), I'd be having a child going to college when I am in my 60s. So will then need a higher number. My approach is to be ultra-conservative and over-save. Including expected inheritance I am actually at around $1.6million right now. But I aim to accumulate at least the $2million without counting on the inheritance. My simulations show me hitting around $8million in total at age 60 under optimal conditions.

makingourway said...

Wow, what great comments!!
Fin indie, you can see our revised monthly budtget here. It has our monthly spend at $11,790. However, we can probably eliminate $680 of disability insurance and $480 for cild care as we'll be retired and have LTC in place anyway. We can also eliminate $185 for Grandma's health insurance. That brings our monthly spend to $10,435. If we knock $3k off, we're at $7.4k. That's pretty much where things are at. So it's a bit better than the $9k, but not that much better. I guess wejust spend more.

Moom, we are planning on $10M in nominal dollars. The $4.2M aggressive estimate and the $5.2M conservative estimate are in today's dollars. We do have about 30 years to save. Unfortunately, I cannot count on any inheritence. (I should, but my parents are not big savers and my siblings will need more help than us).

I have not yet tried a monte-carlo simulation to identify the most probably scenario for our retirement. I will research the tools, however, I wonder if it makes sense holding off until we finalize our investment plan, that way we can model the effectiveness of the plan within the context of our retirement - do the simulations model performance of specific investments or investment asset classes?


Anonymous said...

I can see a lot more things that will knocked out of that budget. You'll need to pay property tax but no mortgage. The life insurance too. You won't spend $1059 on groceries when there are just two of you probably. If you need to reduce spending you'll be able to spend much less on cars. Probably another $3500 per month can be cut out there without reducing standard of living.

makingourway said...

I'm going to have to put together a more detailed posting of what I expect our retirement budget to be.

It will help answer most of these excellent questions.



Anonymous said...

This is a great subject - I tried to post several days ago questioning your assumption on this point. Seems to be working today!

Probably you can live quite comfortably on even less than $9000/month, assuming that you own your home and that it's just the two of you.

We're in a similar situation, with four college-bound kids and my grandmother living with us (and largely dependant on us). Our expenses are going to drop hugely when it's 2 vs. 7 people. Also, we've noticed that there's often a point in the older retirement years when people just don't spend much because they no longer travel or even go out for pleasure, have all the "things" they want, and don't yet have big medical expenses.

This is all very interesting - according to one on-line health insurance calculator my life expectancy is 102 and my husband's is 88, so for us a plan which doesn't dip into principle is important! Indeed, my grandmother is 101, so maybe that calculator isn't far wrong ...


makingourway said...


I like the way you think. You're totally on target.

However, I'd like to be a doting grandpa and travel alot as well. So for myself, I want the full $9k/month.

One thing to contemplate is the cost of aging. What help will you need when you are old that you do not need or pay for now?