Let us use saving for retirement as an example. The first thing you would want to know is the amount you would spend in the first year of your retirement. You’d then want to inflation-adjust that amount each year through retirement.
You’d then want to know how long retirement will last. A 100-year life expectancy is what I would assume but you can adjust that number to what you think is right. Average life expectancy for anyone born in these United States is eighty years.
You can use these pieces of information to know the target amount to save up to that will generate the income you need in retirement. This process of taking money out of your savings is called annuitizing your savings.
But once you know the target amount to save up to, you’d then want to bring that amount to the present, assuming reasonable rates of return. You would then subtract from that what you have already saved, and that difference is the amount you’d want to save from now till you retire.
So, say you are 50 years old and have $1.75 million saved spread across several accounts. And you want to retire in 10 years and draw $75,000 in inflation-adjusted income for 40 years in retirement. That is planning for a 100-year life expectancy that we just talked about.
How much more would you need to save each year till you retire? Crunching the numbers gets us $32,000 to save each year.
But say with everything remaining the same, you want more spending buffer that allows you to draw $100,000 in income from your savings. This will now require you to save $130,000 each year.
For $25,000 more spending power, you need to now save FOUR times more each year. How? That is because you are drawing $25,000 more in inflation-adjusted money from your portfolio for 40 years in retirement, but you only have 10 years to save for it. And blame compound interest for that twisted math.
But say that savings goal is tough to meet, and you can delay retirement by just two years to age 62. To guarantee the same $75,000 income stream for now 38 years in retirement, you only have to save $5,000 more each year. Much easier.
And for a $100,000 annual income in retirement, you’d need to save $80,000 more each year. That is a far cry from the $130,000 required before. Two years of working more eases things quite a bit.
Knowing how much to save for a big goal like retirement sorts other things out in life. Once you know that you are on track, you can then spend freely on things that matter in the present knowing that the future is taken care of.
Thank you for your time.
Cover image credit – Vlada Karpovich, Pexels