Retirement Tips

Retirement Investing - How Much Should You Save? - Part 1

October 17th, 2006 by Papabear

Retirement age is often called “The Golden Years”. One thing is certain. Retirement will be a lot more fun if you have enough gold to enjoy it. What follows is a summary of what I’ve learned from reading a number of books on retirement planning and setting up retirement accounts. To make it more readable, I’ve broken into 3 parts. Here’s Part 1.

In these steps, I’ve kept the math in the example simple to make the process easy to follow. Some folks have written entire books on this subject, and they make excellent reading when you’re ready to get into the process in detail. First step through the process in this simple example and then go into greater detail by doing a little research on your own when you are ready to set up your own retirement savings plan. The important point is - don’t delay getting started until you understand every complex twist and turn of the tax laws and all the investment options. That’s what the pro’s are for. Begin by understanding the basics and then get started. As a friend of mine says about any worthwhile project “It’s more important to get it going than to get it perfect”. So in the famous words of Nike - “just do it”.

Step 1 - Determine how much income you will need to have a comfortable retirement lifestyle. The old rule of thumb many investment advisors recommended was 80% of your current income. However, that’s a very general guideline. You really need to examine your own situation for a better number. Is your home paid for, or will it be paid for when you retire? Then you won’t need money to cover a mortgage payment. If you and your spouse are driving 2 cars now, will you cut back to one car? That’s one less car to maintain or eventually replace. If you currently live in a large house, will you be moving to a smaller house? That’s less for utilities, and the proceeds from the sale of the larger house can go into your retirement account. You’ll also have to factor in that you will have new expenses you didn’t have before. You may need to buy more medicines as you get older. If you have a health plan from your current employer, your share of the cost may go up. You will also probably want to buy Medicare insurance to cover your share of medical costs not covered by Medicare.

Step 2 - Determine what rate of return you believe you can get on your retirement savings. There are many references out there on what rate of return to use for retirement planning. Let’s try to keep the math simple. According to a research report prepared for the Social Security Advisory Board in 2001, the average real rate of return for stocks from 1946 to 1998 was 7.8% after inflation. That seems like a good time period to use because it avoids the Internet boom and bust between 1998 and 2002. This is 7.8% in real, not inflated dollars.

Of course, 7.8% is truly an average over time. In some years the stock market has done very well. In other years, it has taken a big slide. It can be very hard to predict a rate of return over a short period of time. So for the sake of simplicity, let’s round the 7.8% up to 8%. For your own planning, if you want to be more conservative, you can always use an even lower rate.

Tomorrow in Part 2, we’ll walk through some simple calculation to determine how much you need to save to provide the monthly income you need.