The Horizontal and Vertical of Retirement Planning
Our experience with retirees is that lifestyle and longevity are the major determining factors for evaluating the appropriate level of investment savings. While the rate of return is important, it is secondary to the annual spending need and concerns about outliving one’s savings. Following is a more detailed summary of these factors and other items to consider.
The Horizontal of retirement planning is related to the timeframe of your nest egg: “How much longer will you be able to invest in order to accumulate retirement funds?” versus “How many years will your funds have to last?”
For every additional year you continue to work and accumulate, you actually gain two years. This is because you are giving your investments an additional year to grow, plus that is one year less that you will be withdrawing funds. What this means for you is that the longer you can put off retirement (taking distributions from your assets), the higher the likelihood that your funds will outlast your life (if you are single) or the life of your spouse to pass (if you are married).
The Vertical is: “What percentage of your current income are you are spending, not saving?’ For example: if you are spending 50% of your gross income, with roughly another 30% being used for taxes, that means that about 20% is available to add to your retirement savings. The lower percentage you consume, you again get a “double benefit.” First, you are lowering the consumption level that needs to be maintained in retirement, which means you will need fewer resources in retirement to sustain that lifestyle. Second, this allows you to add the amount you are adding to your retirement savings and increase the overall amount available.
The 4% Rule
Recent academic studies have concluded that approximately 4% is a “safe” rate of withdrawal for retirement assets. This means that on a $1 million investment portfolio, a retiree can reasonably withdraw $40,000 per year initially, but then also increase that slightly every few years so that the investment portfolio can continue to grow, which will help offset the effects of inflation. Current rates of return and inflation, along with your base level of spending (income needs) ultimately determine how long your retirement nest-egg will last.
Start Small, and Take Incremental Steps
If you are living on 100% of your take-home pay, we recommend a bit of detective work to see where you are spending. Then, develop a simple strategy to take small, incremental steps to improve your “vertical.” If it seems impossible to save anything, start with $100 month. Then keep increasing the amount until you gain some traction. Over time, you will realize it is possible to improve how much you are saving, and at the same time, lowering your lifestyle to a sustainable level long term.
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