Monday, September 11, 2006

What's Enough?

There's definitely more than one way to define what it means to have enough money. One basic way is to define it as "having enough money so that you can maintain your current standard of living without having to work for money."

So how much is that? There are a number of calculators on the web that let you put in a number of different assumptions and come up with some number that represents enough. It's worth trying a few to see how much the answer varies. Just Google "retirement calculator" to try a few.

Here's another quick and dirty way to come up with an approximation in one line using Google. The simplest way to illustrate it is with an example. We'll assume the following for our example:
  1. Your household income is $60,000/year.
  2. You'll want to retire in 20 years.
  3. You'll be able to maintain your current standard of living on 85% of your current salary (it's assumed that once you retire, you'll save on things like commuting costs, work clothes, etc.).
  4. Your savings will be invested in a typical allocation of approximately 60% stocks/40% bonds.
  5. You'll be able to withdraw 4% of your savings the first year of retirement and increase that by the rate of inflation each year thereafter.
Using Google's built-in calculator, just type the following in to a Google search box and hit enter:

The answer: $2,536,980.80

This represents how much you would need to have saved up 20 years from now in order to be able to "live off your savings." If you're already there, great! If not, having a goal in mind can help with Getting to Enough.

So what did the gibberish that you typed into Google mean? Let's break it down:

(1.035^20) This represents the compounding effect of inflation of 3.5% inflation over the next 20 years before retirement
*60000 This represents our assumed current salary (and assumes that this represents our current standard of living)
*.85 This is assuming we will be able to live off the equivalent of 85% of our current standard of living at retirement
/.04 This represents being able to take out 4% your savings for the first retirement year's expenses

Replace the numbers in our assumption with your own numbers (especially your salary and the number of years to retirement) to come up with your personal approximation of "enough." A warning, though: Don't be too optimistic about how much you can take out that first year (don't go much above 4%) and don't be too optimistic about inflation (don't go much below 3.5%) in an effort to lower the amount you feel you need.

Of course, one line in a calculator or Google can't give you a definitive answer as to how much money is "enough," but at least it will give you a starting point. The answer will also vary according to the assumptions we made and I'll explore how I came up with these assumptions and how they might change in your own case in future posts.

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