The nature of retirement has changed. When the age pension was introduced in 1908, life expectancy was 55 for men and 58 for women. With age pensions kicking in at 65 and 60 respectively, politicians weren't expecting a significant tax burden, nor did retirees require a great deal of money – the “Golden Years” often didn't last long!
Today we can add 25 years to our life expectancy (and that means longer for half of us).
And retirement is no longer about stopping work. It’s about doing the things you’ve always wanted. It’s not about looking backwards, but looking forward. It isn’t an end, it’s a beginning.
My 25 plus years of talking to people about their money has proven to me that if you have clear objectives, you do better with their money, and you tend to live a better life as well. If you go to the trouble of setting a target, you’re more likely to do something to achieve it. Clear objectives give you purpose, direction and focus.
This is where "your number" comes in. Everybody has one, and not knowing it can be devastating to your future.
Your number is simply the estimated number of dollars you’ll need to save so you can stop working. That’s it. Sounds simple, but finding your number can be complicated. Many factors must be considered:
As you can see, it is quite a sophisticated calculation, but worthwhile and easy rarely go together. Some feedback I received from a client recently about this process went something like this:
“It was a bit confronting at first. To know that if we wanted to live like ‘that’, we would have to save ‘this’ first. Having this number in mind though gave us something to measure our decisions by. Would this choice take us further away or closer to our number? Some times that meant putting things off for another day. But that’s the discipline we got from having a target and a plan to get there”
While there is no substitute for doing things properly, to give readers an idea of how much capital is actually required to fund a long term income, let’s consider this very commonly used rule of thumb:
In retirement you can withdraw 4% of your assets each year.
The influential study that explains the 4% rule is the Trinity Study conducted by University Professor, William Bengan. It set out to determine "the safe withdrawal rate" (or how much you can spend each year without running out of money) for an investment portfolio of 50% shares and 50% fixed interest. Using historical share and bond market data to assess the ups and downs of markets from 1926 to 2009, the study found that the safest withdrawal rate was 4%. Bengen said:
"Assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal of 4 percent, followed by inflation-adjusted withdrawals in subsequent years, should be safe. In no past case has it caused a portfolio to be exhausted before 33 years, and in most cases it will lead to portfolio lives of 50 years or longer."
Another way to think about this is to use the inverse of 4% (or 25). If you have 25 times what you think you'll need from your portfolio for your first year of spending (after accounting for Social Security and other non-portfolio sources of income), you can feel confident that you'll have enough to last through 30 years of retirement.
Is the 4 percent rule perfect? No. Is it ironclad? No. Should it be relied upon? No. It’s a rule of thumb and it's not designed to be. It’s a starting point and a way of understanding the size of the task ahead.
Obviously, the big problem with all retirement planning is the unknown. You don’t know what inflation will be or how well your investments will perform. Health, future income needs, life expectancy, the cost of a new car are all unknowns. Hence figuring your real number takes a bit more work.
To help you navigate through this, we use innovative tools that allow you to visualise ‘what if’ scenarios about your financial life.
We can evaluate all kinds of potential options for you. Watch what happens to your retirement nest egg when you increase spending. Look at the net effect of something important like downsizing your house, or selling your business. See the ongoing result of gifts to your children or your favourite charity. Find out more here.
It seems to me there are two ways to hedge your risk of falling short. Cut spending now, to bolster your annual savings and investments. Cutting your cost of living helps you twice: it gives you more to save now; and, if you will keep the cuts in place after retiring, it reduces the size of the nest egg you require. (This is a subject for another day, but I think most people could retire years earlier simply by keeping their cars for 10 years instead of 5.)
Second, think of a fallback retirement plan. Sure, we all like to think of retirement as an endless vacation full of exotic travel, second homes and spoiling the grandchildren. But what’s the minimum you’d need to be happy?
Me? Give me family, health, and interesting people to interact with …. I could live with that.
If you haven't already, take some time to figure out what "Your Number" is. While there are no guarantees, you can and should have something to aim for. You can always make tweaks and adjustments along the way.
Disclaimer - This article is based on generally available information and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider obtaining financial, tax or accounting advice on whether this information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. See full Terms and Conditions here.