Are you retirement ready?
ALSO READ: Bowie Bonds (Yes, as in David Bowie)
There’s no doubt that retirement accounts are an absolute necessity – but so many of us haven’t done a single thing to create one. The most common reasons are “I just don’t have any money to put aside” or “Retirement is eons away, I’ll take care of it some other time.”
If that’s you…it’s time to get your butt in gear and start doing something about it.
However…if you’re on the other side…if you’ve got a retirement account and are making regular contributions…then great. That’s amazing and we totally commend you – but we just have one question for you:
Will you have enough?
Financial advisors from here to Oz have always relied on a very simple rule of thumb to guide retirement planning: the 4% drawdown rule. Withdraw 4% a year of your total retirement assets once you decide to hang up your work boots and you should be fine for 30 golden years.
Let’s say you had a goal to retire with $500,000 in your bank account. Not bad, that’s half a million dollars, right? Half a million can buy you a bunch of stuff.
Using the 4% rule, you’d be withdrawing $20,000 a year and your balance would slowly fall each year as you took out money to cover your expenses. Assuming you took your money out of your retirement account completely…that would last you 25 years.
So if you retired at 65, you could leave a meagre existence until 90. And then you’d run out of money. We say meagre because $20,000 is not much when you consider that, according to the Bureau of Labor Statistics, the average American household’s annual expenditure is $51,000.
There are caveats, of course. This number of $51,000 includes housing costs and if you make it to retirement with a fully-paid off house, then your annual expenses will go down quite a bit. Also, you’ll receive some money from social security which should help…but it won’t be much. The average Social Security benefit is around $1,000 a month – or $12,000 a year.
However, there are a number of notable lessons here.
The first is that you’re probably going to need a bit more than $500,000 when you retire.
The second is that you’ll likely want to keep your money invested, albeit while changing the complexion of your portfolio, as you apply the drawdown rule. Keeping your money invested while moving your investment profile more into fixed-income will allow your money to grow – while keeping your risk low.
You’ll also need to consider that in retirement, expenses tend to rise. They just do. With all this free time comes the ability to use it…and generally that means you’ll be spending more. Also, when people think about expenses, they tend to think about car payments and groceries…but not weddings or family vacations. In a spreadsheet, a vacation looks the same as a heating bill but many people fail to take the cost of these ‘enjoyable expenses’ into account.
So…what should you do?
Start by figuring out what your expenses will be when you retire. You can do right now by tracking your current expenses. Once you’ve got a good idea of how much you spend in a given year, you can use that to project how much you’ll need to save – based on the 4% drawdown rule.
You’ll also need to take a look at how you want your personal retirement to be. You’ll have to spend some time visualizing what you want your life to look like when you’re done working for the man.
- What do you want to spend your time doing?
- Do you want to travel indefinitely?
- Are you the type who wants to continue working, just on other, more personal causes?
Whatever your personal path is, you need to spend a bit of time thinking about it.
This is obviously easier for those who are closer to retirement than those of you who have 35 or 40 years to go. It’s also a safe bet that, in general, the expenses of a 25 year old are going to be lower than that of a 45-year old. If you’re in your early 20s and starting to think about retirement…it may be just slightly harder to figure out how much you will need at 67…but it’s not impossible.
Someone in their twenties should focus on living within their means. They should be saving and investing as much as possible, and starting to grow awareness about their finances. By all means, put down some goals and work towards them. Just know that these are almost certainly going to change and grow as you do.
Or simply use the average U.S. household annual expense as a proxy. If you’re an average American then you’ll probably need $1.25 million dollars when you retire. Applying the 4% drawdown rule here means that you’ll be withdrawing $50,000 a year, every year, until your account is depleted. That should hopefully last you the rest of your years.
The next thing to consider is…how do I get to 1.25 million? What does it take?
It depends. On a lot of factors. What sort of return will you get?
Let’s say you started investing at 25 and retire at 67. That gives you a time horizon of 42 years. If we assume that you invest 100% of your portfolio in the U.S. stock market – which means an average return of 7% per year – then you would have to save about $5,000 a year, every year, to get your $1.25 million. Piece of cake.
When you break it down like this – and you can use many online calculators to see exactly how changing the amount you invest affects your investment – you see that the goal of retiring with $1.25 is actually more manageable than you might have first thought.
$5,000 a year works out to saving just over $400 dollars a month. If you can commit to saving $420 dollars a month and invest that with the goal of achieving a 7% annual return then your nest egg will be pretty secure.
Or you could just win the Powerball. Whatever’s easier.
To learn more about how to properly prepare for retirement, check out this course on building your nest egg!