Determining how much money you need to retire depends on how long you need your money to last – here are key points to consider.
Justina R. Welch, MBA, CFP®
TIME HORIZON: Your age at retirement is less important than how long you need the money to last.
First, determine your investment time horizon, which is an estimate of how long your money needs to last and has a dramatic impact on how much money you need to retire. Your investment time horizon will depend on individual goals and objectives and may be over your lifespan, your spouse’s lifespan or may be longer if you have a goal of leaving a legacy when you and your spouse are in a (hopefully) better place.
When thinking about your time horizon, it’s important to note Americans are living longer and longer lives. On average, a baby born in America today will live to be over 78 years old—an increase of more than 30 years since 1900. As medicine, hygiene and overall living standards have improved in the US, so too has life expectancy increased—along with the share of Americans reaching what many consider to be advanced age.
The average person in their mid-50s can reasonably expect to live another 30 years; one in their 60s can expect another 20 years; and even a person in their 70s can expect to make it another 10 to 15 years. Plus, remember these are median life expectancies—half of investors will live longer. This is great news—it’s hard to complain about living longer! That being said, a longer lifespan does present risks—like outliving your savings. These general views of America at large must be further augmented by evaluating your situation uniquely. Assess your family history. When did your parents pass? Other close family members, like siblings and grandparents? Are you in better or worse health than them? Don’t underrate your health. It is more prudent to overestimate your time horizon than underestimate it.
INFLATION AND EXPENSES: “Stealth Taxes” can wreak havoc on your retirement.
Next, estimate what your expenses in retirement will be. Your potentially longer lifespan requires some thought about changes to your cost of living. Don’t underestimate how much impact inflation can have. It decreases purchasing power over time and erodes real savings and investment returns. Since 1925, inflation has averaged 3% a year.i If that average inflation rate continues in the future, a person who currently requires $50,000 to cover annual living expenses would need approximately $90,000 in 20 years and about $120,000 in 30 years—just to maintain the same purchasing power!
Additionally, your cost of living in retirement may include expenses in sectors that have historically risen faster than the average rate of inflation, such as education or health care. Perhaps you will be helping a child or grandchild with college tuition—an expense that far outpaces average inflation in recent years.
Or, consider the major influence of health care on retiree budgets. As people age, consumption of health-care services, devices and medications typically rises. And this increased consumption is in a category with relatively fast-rising prices.
INVESTMENT GOALS: Essential for investors of any age.
This is a crucial step: An investor without goals is like a rudderless ship. Define your goals by answering the questions: What do you aim to achieve with your savings?
“I want to avoid running out of money during my lifetime.” That is probably the most commonly expressed goal we hear from clients. If this is exclusively your goal and you are 100 years old, chances are you could get by with a portfolio of cash and income-generating securities. If you are 40, this goal probably implies getting growth to build your assets, requiring a more diversified, risk-oriented portfolio. If you are 65 and tapping your portfolio to meet expenses, the choice of what to invest in will be crucial and should hinge on your actual needs, not your age. Age is just a number. Furthermore, if you have a secondary objective—like leaving funds for your heirs—your age may be totally irrelevant.
Clearly defining your goals is critical to your investment success. This is true if you’re many years from retiring, retiring at 65 or working for the rest of your life.
SO, WHAT DOES ALL THIS MEAN FOR SOMEONE WHO WANTS TO RETIRE AT 65?
There is no exact formula for how much money you need to retire—at 65 or at any age—because everyone has different time horizons, different expenses and different goals. Maybe the question isn’t how much money you need to retire at 65, but how to make your money last for 20, 30 or even 40 years. The “number” isn’t about hitting some magical threshold; it’s about knowing your goals and understanding thoroughly what it will take to get there, regardless of your age.
iSource: FactSet, as of 03/08/2016. Based on US BLS Consumer Price Index from 1925 to 2015.
