I hope you enjoy the 4th post of my ‘Understanding Retirement Planning & Investing’ series! If you’ve missed the first three posts be sure to check them out!
A few weeks ago Joe was driving through the state of Kansas and noticed a large barn on the side of the road. It wasn’t the barn that caught his eye, rather it was the 3 targets painted on it that had arrows sticking out. All the arrows were perfect bullseyes!
You see, Joe had grown up hunting with his father and had recently become fascinated with archery. He’d been practicing for months and while he was getting better he surely wasn’t capable of hitting one bullseye, let alone 3 in a row!
With his curiosity getting the best of him, Joe pulled up the farmers driveway, parked, and knocked on the door.
The farmer opened the door and Joe said, “sir, I’m sorry to bother you but I was driving down the road and noticed the targets on your barn with 3 perfect bullseyes! I’ve been practicing archery for months now and I simply must know how long it took you to become that good?!“
“Well,” the farmer replied, “I got a bow for Christmas and had never really shot before. So, in all honesty, those were my first three shots of my life.”
A little appalled and embarrassed Joe stammered, “Are you serious? I’ve shot hundreds of times and I’ve only been able to get 1 bullseye.”
Seeing that Joe had gotten it all wrong the farmer responded, “No son, you misunderstood. You see, I took the new bow out, shot three arrows, and then painted the targets around the arrows. I didn’t really shoot those bullsyes. I just wanted it to look like I did.”
I heard this joke from one of my co-workers a few months back. While it’s funny, it’s the reality of how most people plan for retirement.
We don’t plan ahead and our lives in retirement are simply molded (“painted” in my analogy above) around the assets and income sources that we have when it’s time to ‘hang up the boots.’
The truth for the Average American is that life in retirement will never look like so many of us dream. We fail to save properly which has caused retirement to become an act of survival instead of ‘living the dream’ that so many originally hoped for.
One of the main reasons I became a financial advisor was due to the fact that I became increasingly concerned with my generation’s ability to save for retirement.
With the recent news that Social (In)Security is projected to run out of reserve funds by 2033, it’s never been more important in the history of our country for people to start saving, properly, for retirement.
If you want to retire comfortably then YOU MUST START WITH THE END IN MIND.
What do I mean by that?
Well, the question you must answer if you want to retire is “how much MONEY do you need to live?” NOBODY, should retire without knowing that number.
For our clients we help them come up with two income figures and we have them figure this out in today’s dollar:
Once you have a monthly dollar amount (in today’s dollar) that you’ll need in retirement, there are a few things you must take into consideration:
1. Inflation – the reality of inflation is that prices for goods double, on average, every 20 years. Assuming a 3.5% average rate of inflation.
2. Age – how much longer do you have until retirement?
Example: Let’s say Joe and his wife are 35 years old and they have two young children. They plan on being debt free by retirement (excluding the house) and both of their children will be graduated from college around that time as well. Their dream is retiring by 65 so that they can enjoy their remaining “younger” years and also hope to have time to spend with their eventual grandkids.
Understanding what their monthly expenses are today, and acknowledging a few costs will be gone once the children are grown, they determine they’re going to need $3,000/month in retirement to survive.
Adjusting that number for inflation (3.5%) they’re able to determine that by age 65, Joe and his wife will need $8,420 per month in order to ensure all of their monthly bills are being paid.
WOW! The affects on inflation are scary! Maybe that’s why nobody wants to take the time to calculate what they’re going to need in retirement?
Determine the amount of investible assets that you need in your nest egg to produce $8,420/month of income:
1. Multiply by 12 to get the annual income amount. $8,420 x 12 = $101,040
2. Divide that annual number by .04. $101,040 / .04 = $2,526,000
While this topic is widely debated, generally a good rule of thumb is to assume that a person can withdrawal 4-4.5% of their assets on a yearly basis, AND NOT HAVE TO WORRY ABOUT OUTLIVING THEM. In step 2 when I divided by .04, that is how we work backwards to figure out the 4% part. 4% of $2.526M = $101,040
Once you’ve figured out “the number”, then you must create a plan to get there!
This is where the majority of us fall short. We see this HUGE, insurmountable, ginormous number ($2.5M) and we freak out. Well, sticking your head in the sand doesn’t do anybody any good!
Pushing it off ‘to another day’ also doesn’t help the situation. If you keep saying that ‘I’ll eventually get there, or I’ll start saving when “xyz” happens’, then I promise that YOU’LL NEVER GET THERE!
In the scenario above, Joe and his wife would need to start saving approximately $1,400 PER MONTH* in order to reach $2.5M by the time they turn 65. *assuming a 9% average rate of return and assuming they didn’t have any other prior retirement savings.
While initially this may look daunting and you may be wondering how in the world to save $1,400 per month, there are some things this doesn’t include:
1. Determine monthly income need (in today’s dollar) – it’s easier for most to know their monthly need as opposed to figuring out an annual number.
2. Adjust for inflation based on your age and projected retirement date – I like to use 3.5% as my inflation rate.
3. Convert monthly amount into annual figure – multiply your inflation-adjusted monthly income number by 12.
4. Divide the inflation-adjusted annual number by .04 – this will give you a lump sum number that you need to have by your retirement date.
5. Determine and develop a course of action to get you to “your number.”
Now, many of you can see why I’m scared for my generation. These numbers aren’t make-believe…THEY’RE REAL! What is going to happen WHEN Social Security runs out? Will people EVER be able to retire if they’re solely reliant on the assets they’ve saved?
The articles are written by personal finance enthusiasts (not certified professionals) based on their personal experience. What works for them may or may not work for you, and you should always consult a financial advisor before making important financial decisions.
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