“How much money do I need in my retirement accounts to retire happily without worries?” This is a typical question people ask me often. It is an excellent question. An integral part of your goal is having a firm idea of what, exactly, you are shooting for. For most people, the most significant financial goal is retirement. Most of us, however, have little idea of how to calculate the amount of money we will need to save up before retiring.
Before I answer this question, it is vital to ensure that two other important saving goals are met: enough money in your operating fund (your checking account) and emergency fund (your savings account). This emergency—sometimes also called contingency—fund is the money apart from the checking account that you have put aside for unforeseen expenses or for when you have some other emergency. I recommend having three to six times your monthly expenses in this account. You use the operating fund to pay your daily and monthly expenses. You should have an amount equal to one to two months of your monthly expenses in that account. The rest of your money is available for investments for retirement and other goals.
There are many variables when calculating how big your retirement fund should be. In fairness, there is no way to determine precisely how much money you need to retire—especially if you are many years away from that milestone. No matter how sophisticated your analysis, it cannot be done with complete accuracy. There are too many moving parts and unknowns, like what everything will cost by then, your future earnings, your health at retirement age, etcetera.
So, let us keep it simple and focus on what you can determine: how much you want to spend in your retirement years. A good starting point for analysis is to take your current annual spending and adjust either upward or downward based on assumptions about, for instance, (1) extra fun spending, (2) no more mortgage payments, (3) no more support for children, (4) your health now.
Based on historical evidence from multiple studies performed in the United States (and Mr Bengen’s study
is the most frequently referred to), a starting withdrawal rate of more than 4 percent (in plain English, spending more than 4 percent of your investment portfolio) has led to an undesirably high likelihood of running out of money during thirty years of retirement. Therefore, as a rule of thumb, financial advisors recommend that your retirement funds be at least twenty-five times your annual spending. Of course, this is just a guideline. There is no guarantee that it will always work out like this. If your retirement period is over thirty years, you might need to spend less in the first years or require a larger retirement fund.
For the sake of simplicity, to calculate what you need in your retirement fund, we multiply the expected monthly spending by twelve to annualise it and then by twenty-five.
