Step too far outside the realm of Money Wizards, and you’re bound to hear plenty of “alternative facts” about how much money you need to retire.
The unfortunate truth is that most of this misinformation simply comes from people still stuck in an early stage of retirement planning. The even more unfortunate truth is that most people will never break through these early stages.
And the most unfortunate truth is that because of this, most people will continue devoting years of their lives to a career they no longer enjoy, even when freedom is hiding in broad daylight.
Level 1 – Most People
At the most basic stage, we have people who go through life never really thinking about their money. These types will throw around the wildest estimates for how much retirement costs.
This was blatantly apparent in a recent New York Times piece on the cost of retirement. Check out some of this madness:
A 32 year old tour guide guesses he’ll need just $20 million to retire:
Twenty million dollars. That’s how much Julien Mellon needs to live the life he wants. With that kind of cash, Mr. Mellon, a 32-year-old tour guide, could buy a “beautiful” home with enough left over to spend $100,000 a year (“in 2017 dollars”) until the day he dies.”
The owner of a small skin care company agrees:
Twenty million would allow her to put her 17-year-old daughter through college, “give to philanthropy — especially women’s and children’s causes — start another company, and travel as part of work combined with personal pursuits,” said Ms. Hilling, 58.
A 42 year old stay at home mom has a specific idea of enough:
For Ms. Falcon, “enough” is somewhere between $8 million and $10 million, so she could give her daughter “the best of everything,” as she put it: “Private school, college, money for an advanced degree at an Ivy League university, two homes, unlimited vacations. Retirement. Cars, gas, food, shelter, extras. I’d also like to make sure my mom is set for life not having to worry about money.”
A 51 year old teacher with half a million in the bank admits she panics “all the time about not having enough.”
Her number hovers around $65 million… “We’d travel cheap and dirty, with immersion in mind.”
Holy s**t. If you really thought you needed that much money, reaching retirement would feel as impossible as winning the lottery.
No wonder most people don’t save any money.
Level 2 – Financial Planners
One step up the Ladder of Retirement Estimations are the supposed most expert of money experts, The Financial Planners. These guys live for the scares more than a minimum wage teenager working a haunted house.
Ask the average CFP how much money the typical person needs to comfortably retire, and they’ll do some hand waving before throwing out a devastatingly large number… usually in the range of about three million dollars.
The exercise usually goes something like this:
- Calculate your current annual salary.
- Determine what size portfolio you need to replace this salary, dollar for dollar.
Armed with this process, the financial planner runs the number for John and Jane Doe. John is a firefighter earning $50,000 per year, while Jane is marketer earning $60,000 at her office job.
- Combined household income: $110,000
- Arbitrary hand waving about pre-retirement income replacement, estimated dividend and bond payments, and hyper-inflation in postwar Germany…
- Presto! John and Jane need $2.75 million to comfortably retire!
Wait, what?
Killing the Myth of the $3 Million Dollar Retirement
The absolutely massive assumption here is that everyone spends their entire salary on everything. The typical retirement planner uses the magic of a 0% savings rate to trick hard working folks into believing retirement is an expensive, if not unattainable, dream.
Some of the more risqué retirement planners will phrase the puzzle as a percentage of your income, claiming retirees usually need somewhere between 70-100% whatever they are currently making.
And as one notable early retirement blogger with a mustache once said, “Whenever you see anything listed as percentage of income, you should start getting excited, because it means there is wasted money in the air.”
The idea that it costs millions of dollars to reach retirement is the same line of thinking that it costs $75,000 a year to live comfortably in the United States, or that weddings cost $32,641. There’s some serious guesswork there destined to send your ass to a wasteland of spending.
Even worse, some armchair retirement planners take the wacky assumptions about retirement even further. They ignore investment returns all together!
I noticed this amazing phenomenon in the responses to my mainstream articles. When I told CNBC I was aiming for $750,000 with estimated expenses of $30,000 per year, a disturbing number of readers ran the math and decided since 750 / 30 = 25, I’d be broke 25 years into my retirement.
They completely forgot that a $750,000 portfolio will continue compounding.
Saving away for retirement with this approach would leave you spinning your wheels forever.
How Much Do You Actually Need to Retire?
There’s really only one factor you need to consider when determining your retirement number:
What are your expenses?
Someone who can live happily off $1,000 per month is going to need a much different retirement portfolio than Johnny Depp, who somehow spends $2 million a month.
I’d recommend Johnny Depp pump the breaks before his inevitable bankruptcy, and I’d recommend the rest of us agree we don’t need to spend like a movie star in retirement.
With that out of the way, you can now explore options for building up enough savings to fund your lifestyle forever.
These savings could be all cash, as our CNBC commenters were assuming, but this is not ideal. Cash is highly exposed to inflation, and thanks to the rule of 72, we know that cash loses half its value every 24 years or so. Equally bad – withdrawing from an all cash savings account poses a direct hit on the amount of funds left.
For maximum safety, we want to be living off the interest. By building up a portfolio capable of generating returns to cover your expenses, you avoid touching your savings entirely.
Stocks and bonds are pretty perfectly suited for this task, since they’re some of the most passive investments with the longest history of strong returns. Ideally, as the stocks and bonds work away to generate income, the value of your portfolio rises.
As the portfolio continues growing, we just need to find a safe withdrawal rate.
What’s a Safe Withdrawal Rate?
Well, Google defines the safe withdrawal rate as the percentage of your portfolio that can be withdrawn per year, without running out of money before you die.
But of course, you didn’t come here for something you can quickly Google. So what’s the actual safe withdrawal rate, as in… the actual number?
The most widely agreed upon safe withdrawal rate, as stated by people who have devoted their lives to researching the topic, is 4%. This has given rise to the now famous, and at times controversial, Four Percent Rule.
We’ll keep the mathematics high level here, because there are plenty of resources which discuss that specific of the rule in more detail than you probably care to hear. (Here’s one. And another.)
Basically, back in the 1990s some college professors analyzed what would have happened if someone retired with a portfolio of stocks and bonds at any point since 1925, then withdrew a certain percentage of their portfolio (and adjusted for inflation along the way) over 30 years.
They repeated the rolling 30-year calculation for each of the past 70 years, apparently running the whole thing through some sort of super computer, and concluded that withdrawing 4% of a portfolio over 30 years keeps you from running out of money, oh… roughly 100% of the time.
Despite frequent challenges from the media and financial planners alike, the most interesting part of The 4 Percent Rule is that by nature of the study, withdrawing 4% was actually a worst case scenario.
Had you been a little luckier than retiring right before a horrible market crash, you could withdraw even more for several 30 year periods throughout history. Certain hypothetical retirees could have withdrawn over 10% of their portfolios every year!
Level 3 – Putting the Safe Withdrawal Rate Into Action
Putting The 4 Percent rule into action is pretty easy, and serves to really KO the myth of the $3 million retirement. Simply multiply your annual expenses in retirement times 25, and you’ve got a quick and dirty retirement number.
For our previously mentioned frugal spender living off just $1,000 a month, a $300,000 portfolio should safely survive retirement.
For a financial analyst and free time blogger planning to live off $30,000 per year, $750,000 is his magic number.
Unfortunately, Johnny Depp needs a portfolio of about $600 million to keep up his current lifestyle. Sorry, Captain Jack.
Is the 4 percent rule exact? No. Is it bullet proof? Of course not.
But neither is throwing out a random multi-million dollar guess, and neither is a financial planner multiplying your annual income to arrive at a massively bloated number.
The Risk of Retiring Early
At some point in the retirement planning process, the hopeful retiree has to accept a certain amount of risk. Going back to involuntary work after retirement is never ideal, then again, is the risk really so large?
If you stick to the traditional multi-million dollar retirement model, you’re subscribing to a 30+ year working career. On the other hand, if you retire early and enjoy a life without wage slavery, but disaster strikes… then what?
You only have to go back to work!
You’re in the exact same position as you started, only with a wonderful sabbatical thrown in between.
Sure, you may not be as marketable, and you’ll likely take a pay cut. Then again, if you’re the type of person capable of accelerating your savings all the way to a very early retirement, you probably possess an above average ability to earn money anyway.
Of course, the chances of this ever happening is extremely minute. Almost impossible, at least historically.
We can do it!
Looking back, I realize how lucky I am. Right around the time I got excited about the idea of retirement, I saw my blue collar grandfather comfortably retire with $1.3 million. Then I saw him live on a fraction of the interest. Shortly thereafter, I read Jacob’s book where he shows how he retired on less than $500,000 and lives off just $7,000 per year.
I started saving like a lunatic, because the goal seemed so attainable. Had I not experienced this turn of events, it could have been me featured in the New York Times piece, wildly throwing about an estimated retirement number of $50 million, then heading to the gas station to buy this week’s lottery ticket.
What’s your retirement number?
If the 4% rule is a little too basic for your tastes, Personal Capital has a pretty awesome retirement calculator. The calculator uses your specific numbers to simulate five thousand different scenarios in the blink of an eye, and then reports back on how your plan is looking. It’s really an awesome tool that I encourage everyone to check out.
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Excellent analysis and thanks for the graphics! Essentially, everyone’s number is different. Some people want a more lavish FIRE lifestyle and will clearly need more, aka the $20M guy above. However, those that are just looking to stop working a 9-5 and spend more time with their family, only need enough to cover their expenses. Reducing spending is a great way to reduce the amount you’ll need in retirement!
Interesting article and I obviously a bit jealous of the knowledge you had gained about money at a very early age. I was a big saver already in my 20’s after graduating college, but I didn’t grasp the benefits of investing until well into my late 20’s after talking with an older colleague in his 50’s explaining how he was making more money through his investments rather than his salary. SO began my investing career sometime around 1988.
For perspective, I hadn’t saved my first $100,000 until age 35 in 1991. Obviously by that time I began to become better acquainted with my future “retired” self and welcomed a somewhat simpler life in order to retire at 55 (I hoped).
Of course, life sometimes comes into play, and unlike another blogger (MMM) who retired at 30, I didn’t always mind the work. I wanted a nice home and waited until I was 30 to buy my first. I believe it was $116,000 four bedroom two-story that I needed to borrow about $90,000 to complete the purchase back when load rates were just over 10%, a much different environment than the 3% rates today.
Luckily for me, I had only one bump in my long working career and lost my first job at age 28 as the company went into bankruptcy. That turned out to be a blessing as my second job came with many more benefits of working for an national manufacturer of health & beauty products.
While my health remained strong and no further job losses appeared during my 39 year career, I did suffer from a divorce in the fourth year of my marriage and essentially had to start anew.
I remember my vision of retiring at 55 with a million dollar portfolio and finally becoming free. I continued to invest and increase my contributions as my salary increased. I survived many cutbacks within our company as we were bought and sold three separate times.
I was 49 in 2005 before I had saved my first million. It would have happened sooner but I ran into a little hiccup called the “Dot.com Bubble” when all those upstart tech company began to implode around March of 2000 and the stock market tumbled over the next three years. I took a few cuts and bruises along the way, but continued to contribute to my investments although less enthusiastically than before the fall.
As you can imagine by my 50’s, I was a bit more jaded by my 25+ years of work related stress. I still dreamed of retiring at 55 as I survived a major reduction in head count at our firm. Older friends were grabbing early retirement packages and the “work” culture was shifting to something less fulfilling. I made it all the way to $1.696 million in 2007, before being confronted by the “housing bubble” of 2008-09 when I saw my portfolio drop by $675,459 to just $1.021 million on March 9, 2009.
But again, while really shaken by the drop and all the press heralding the end of the global financial system, I continued to contribute to my 401k while praying that I wouldn’t lose my job.
Luckily, in what may have been the last time our Congress had really worked together for this nation, the market began to slowly recover from the crash and over time I began to believe once again in financial markets and the promise of what they could provide for my future.
It took four long years for the markets to recover and begin to set new highs from their previous summits reached back in December of 2007. But at age 56, I had followed the path having never faltered from my mantra of saving and investing, and broke $2 mm for the first time.
Now most people would have pulled the plug on their careers at this point and placed that first big toe into the cool, refreshing waters of retirement. But being the conservative person that I had become and the friendships that I had through work, and the fear of the unknown, I continued to work another four years until I finally fell victim to one of many work force reductions my employer underwent during my 35-year career.
But this time it felt right, and that I was being a gift of severance to ease my slide into retirement. That was in January of this year and I am now 61. Perhaps I could have retired sooner, but this feels right for me. By the time my severance runs out, I will be 62 and be eligible to receive my $24,000 annual pension.
I have now accumulated $4 MM in retirement savings. I will go into retirement with a comfortable cushion and the ability to either fund an unexpectedly long retirement into my 90’s or even past 100, or I will certainly leave a reasonable estate to my wife and my two step-daughters.
Could I have retired earlier and survived on what I had saved? Probably. But while I believe I have lived frugally over these past 61 years, I have a reasonably nice house worth perhaps $400,000 that is completely paid off. I recently bought my first car/suv, a Jeep Grand Cherokee Limited (take that MMM), and will live comfortably surviving on a bit more than $30,000 a year in expenses over a shorter span of time.
I would only offer up that life has a way of surprising you when you least expect it. Your young as I would suspect are most of your readers. Your column is quite inspiring, and everyone needs a little kick in the butt along with sound financial advice to get their own “show on the road”. Most people will take from your advice what works for them and will benefit from your motivating them.
Money is a means to an end. If you don’t plan for retirement than you will most certainly never be ready for it financially. So continue to give the great advice, but also know that every plan will likely need adjustment as you go through life. Sacrifice now for your future happiness. But perhaps, not too much as to deny yourself of the wonders of life. Too often people go to the other extreme and deny themselves little and suffer from the weight of their debts for “thing” that often mean little to the quality of your life experience in the long run.
Woah, $65 million dollars to “travel cheap and dirty”?!? I think I would need to try really hard to spend $65MM on travel and lifestyle!
Great article, I like the way you break this down and lay out the perspectives and “common advice” out there. Thank you for another great post!
I know! Maybe Johnny Depp could give us some advice.
Bahahaha, I do like how people choose their magic retirement numbers. The number doesn’t have to be gigantic; it just has to be enough to cover your living expenses without touching the principal balance.
Right now we are projecting only needing $1 million. Depending on when we get there I may end up working an extra year to add a decent buffer to it.
However I don’t plan to stop working entirely. Hoping to do job jumping in to different fields that just means lower wages.
Agreed. I still recall the first time I heard MMM on the radio. He commented that it isn’t saving that dictates retirement, it is spending. Once I realized that in early retirement that my budget would no longer have retirement savings, college savings, or a mortgage, I then could calculate that my spending would decrease over 50%.
We choose the 4% rule when my husband retired at 51. He has 35,000 from the 4% and. I have 20000 from pensions! We have no problems with money! We travel a lot! We maintain 2 boats( one for summer living on and one in Florida for winter living on. We still have our primary residence in Toronto that we own outrightly! And the investment pile jeeps growing each year by 3 to 4%! Yes you can do this! We are in our 11th year of retirement and it is not even difficult to stay.within the 4% guidelunes! Enjoy your blog! Interesting to g hear what the next generation thinjs!
If you are in your eleventh year, that means that early on in your retirement you went through the 2008 financial crisis and you are still fine with the 4% rule. Great work!
My magic number is $900,000. I’m at $760,000 right now. Just a few more years. The goal is to retire before I’m 50 yrs old *fingers crossed* PS – Love your blog – you’re a smart guy to start socking it all away this early – thanks for all the great info!
My magic number is $1.2 million, although I’d like to have a bit more than that saved to feel safer. We’ll see how I feel about my job when I’m closer to having that saved!
With respect to the NY Times article, if I had $65 million dollars in savings, you can bet that I wouldn’t be travelling “cheap and dirty”.
I shoot for a number closer to 3.25 percent, mainly because my target retirement is longer then thirty years (if I thirty years left I agree four percent would be fine per trinity study). The study afterall only states you will have funds left over after thirty years. But beyond that it’s expenses all the way.
Thanks for sharing! I agree with bengen’s 4% SWR. The only scenario I see it not working is a black swan event of epic proportions where you have some serious sequence of returns early on in the retirement, like 5 consecutive years of a bear market since that’ll completely wipe out your nest egg. My goal is $250MM by the way. LOL! =) I have a blog post about it up on my blog.
Best article ever. 1) you forgot social security of $10000 per year for most who work 30 years until 50 years old. 2) you forget to mention to look at some 70 year old people on average. They just sit or go for walks. They spend maybe $10,000 per year at 70 and have no desire to use more ever. 3) stupid risky medical extra costs will be a risk for co payments and drugs as our USA medical continues a poor path of costs.
Holy smokes!! $20 million!?!? That’s insane. Jacob’s book is a great read too. Thank you for the article.
Best,
JT
I would happily go with the 300k and 1k per month scenario and even would let Captain Jack live in my basement after his bankruptcy and share occasionally a bottle of rum.
Our number hovers around $900k-$1.3M depending on how comfortable we want to be, and some assumptions. I’d rather work toward $1.5M but depending on how long it takes us to get there, what sorts of income streams we have built up, etc. that’ll all be used to determine what we need.
We don’t have enough years under our belt to determine what our ‘regular’ spending is after moving, but we can pretty easily strip out some of our excess spending and get a rough guess. Paying for both a wedding and a house this year, as well as a cross-country move last year, has inflated our expenses over the past 18 months.
I’d much rather have too much than too little though, that’s for sure!
As much my knowledge tells, the investments saved in the shape of a home can be used to retire at the older ages. That’s why spending money to own a home during the employment period of life is a good idea. It gives you enough resources to maintain your lifestyle and manage finances when you get old. However, you will get directly vulnerable to the property prices and this is something risky.
Awesome article
Thanks!
That was a great view of your persistent goal to stay on your life’s path
to retirement. Wish you all the best going forward!
Thanks for sharing.