HapiMoney

There are a lot of different ways to do this, and a variety of different results will come because of it. Personally, I choose to stick to more conservative methodologies, but you can be as aggressive as you like.

Here’s how I calculate the amount you need to retire:

1. Figure out what your yearly expenses are: rent, credit cards, groceries, etc.

• It’s probably easiest to figure this out monthly and then just multiply by 12 (to get an annual amount)
• You don’t necessarily have to be exact. The end result is going to vary widely based on your assumptions.

2. Figure out how many years it’s going to be until you retire (warning, this requires basic subtraction).

3. Gross up your annual expenses by inflation for the next X years until you retire.

• Inflation has historically been about 3% per year
• Here’s the formula: annual expenses x (1.03) ^ years_until_retirement

4.  Now you have your cost of living for when you are retired, but since you are no longer earning any salary (you stopped working, remember?), all income must come from your investments.

• Conservatively assume that you are going to earn all of your income from bonds
• Lets assume that the average bond yields about 5% annually
• Divide your expenses from #3 (the grossed up ones) by .05*(1 – T) where T = your tax rate
• Now you’ll have the amount you need to retire.

5. Stop freaking out – it’s going to seem like a lot of money, but keep in mind you will have been saving for all of those years, and your investments will have appreciated significantly.

Here’s an example of how this might work:

• Lets say I’m 30 years old and I have $2500/month in expenses. Multiply this by 12 and I get $30,000. Multiply 30k by 1.03^35 (since I want to retire at 65 and I’m 30 now) and the result is about $85,000. Now back out the amount you need by dividing by 5%*(1-30%) and the answer is $2,400,000.
• Thus, in the year 2045, my $2.4 million will generate $85,000 in after-tax income every year.

Frequently asked questions:

1. Should I Include Payments from Social Security? To answer a question with a question, are you feeling risky? If you honestly believe that Social Security will still be around, funded and viable when you retire, feel free…but it’s a risky proposition.
2. I can’t possibly save that much money by retirement. What assumptions are flexible? Your expenses and the rate of return during retirement are the two easiest variables to adjust for. Stop spending as much money and you are going to see how you need dramatically less to get by on. Also, if you are able to accept higher risk, you can keep more of your retirement fund in stocks which will increase your returns above 5% per year.
3. How can you possibly predict inflation rates? I can’t, but I can use historical rates to give an indication of what the future holds. Here’s a site which does the calculation.
4. Why should I live only off of interest when I retire? Why can’t I just use the notional savings that I’ve accrued? You can certainly do this, but like I said above, I take the conservative approach. Also, what happens when you live longer than you expected and run out of savings? Lastly, do you really not want to leave your family anything? That takes a certain amount of gumption.
5. I’ve got kids, a job, and other expenses now that I don’t expect to have when I’m retired. Should I still include these in my calculation? In theory, no, but you can expect your costs to increase in other areas, like health care, or more travelling. Just be careful when you start lopping off expenses.