How Much do I Need to Retire?
While this may sound like a simple question, the answer is not. A quick and dirty answer can be determined with “The 4% Rule.” Everyone has different goals and budget limitations, so please reach out with inquiries. The 4% rule dictates a 4% annual withdrawal from your nest egg. By determining the desired cost of living during your retirement years and multiplying that value by 25, you can determine your necessary nest egg. The nest egg sustains your cost of living to a 4% annual withdrawal. If you and your family live off $100,000 annually, that equates to a $2.5M nest egg to retire. A $150,000 cost of living needs a $3.75M nest egg. In theory, this nest egg and return on investments should be enough to sustain your desired cost of living through all the years of retirement.
This guideline has assumptions such as retiring at age 65 and a mixed investment portfolio of approximately half stocks, half bonds. This works because a 60/40 allocation of stocks to bonds typically returns 7-8% annually. Considering this portfolio return and approximately 3% annual inflation-- a 4% annual withdrawal will theoretically allow you to live off the annual gains and maintain the principle balance. If the principle is untouched, it will theoretically continue to produce. Keep an eye out for more about portfolio allocation in the future.
If your portfolio is bond or CD heavy, a 3% withdrawal may be more appropriate. If you have no debt to your name and can count on few surprise expenses, a 5% withdrawal is likely safe. The 4% rule has been proven to work in almost all 25-year spans in recent history. Be mindful that major expenses or drastic lifestyle changes going into retirement should be considered carefully in order to keep your retirement on track. Buying a new $60,000 vehicle when you plan on a $100,000 annual cost of living will eat into your investment portfolio and affect your annual returns.
The next consideration is retirement age. Most retirement accounts are not accessible (penalty free) until age 59.5. If all your investments are housed in a 401(k), retiring before that age may be difficult. It is ideal to maximize tax efficient accounts, but retirement shy of age 59.5 will require investments elsewhere.
For those who feel retirement is in the distant future. A rough estimate is as good as you might be able to get, and that’s okay. At age 35, society says to work another 30 years until age 65. A lot can and will happen in that time. Uncertainty is the only certainty. Cost of living will greatly change throughout that time with kids, loans, unexpected events, and hedonic adaptation (lifestyle creep). Inflation will happen. Incomes will change. At the most basic level, inflation and buying power work off the same “Rule of 72” we use for calculating compounding interest. Inflation is between 3-4%. This means buying power will be reduced 50% in 18-24 years. With this in mind, multiply everything you spend today by 2.5 to calculate what prices will look like in 30 years. A $200,000 salary today will be $500,000 in the year 2052. A $100,000 cost of living today will be $250,000 in 2052. Calculating the nest egg for that $250,000 annual cost of living, we see a value of $6.25M. Hopefully loans are paid off and the kids move out as you reach your early 60s and the annual cost of living decreases a bit. Not to mention you may be making $500,000 annually.
Yeah, a retirement account in the mid 7-figures can be intimidating, but manageable starting with a $2,500 monthly investment through your 30s. I am looking for this piece to be informative and educational with a sprinkle of importance. The earlier you can have money work for you, the easier this will be. Really though, please reach out with questions.
There is not a right or wrong answer to portfolio allocation and retirement age. Do what is right for you. This guideline of a 3-5% annual withdrawal rate is your answer to how much you need to reasonably walk away.
