“How much money do we need to retire?” is a question I hear frequently. Answers to this truly loaded question are chock full of variables, differences, and sometimes heavy discussions.
The short answer to the question varies tremendously on a case-by-case basis and any information on the matter should be customized to your assets, liabilities, needs, wants, and goals. While there are some patterns and guidelines, what you need may be different from what your friend, neighbor, or co-worker might desire.
A good first step is to determine family net worth: you and your spouse, or just you if single. Add up all of your assets and subtract debts – your bank money, maybe cash on hand, investments, real estate, and other valuable possession, less what you owe.
I’d suggest incorporating your real estate/home into the equation so that if downsizing comes up, we have some ballpark figures to review. This also helps with estate planning as real estate may comprise a large portion of assets.
From this net worth, consider liabilities or potential future liabilities (roof, etc.). A good rule of thumb is to lighten up on debt as retirement approaches, and if possible, be a little ahead of bigger expenses while you are working and have stronger cash flows.
Scattered investments? It might be a good idea to smartly consolidate.
Now that net worth is calculated, step two is to envision what your retirement expenses might look like. Wealth will fund retirement. To measure what needs funded, it is a good idea to live off your anticipated retirement budget for at least three months prior to retirement to make sure it works.
What will you do in retirement besides pay utility bills, and other common costs? Travel, health insurance, hobbies – knowing the costs of retirement, and what you will do helps answer the “why” of retirement.
Step three is the traffic light.
Does your estimated retirement budget green light you to leave the workforce? If pensions, savings, Social Security, and perhaps IRA withdraws lead to a “yes” answer, great. If you are more of a yellow light, then use caution.
You might consider downsizing your living situation, traveling less, perhaps working a few years longer to increase savings and Social Security benefits, or add a part-time job into your mix. This is where customization often is most helpful.
The fourth step is to look at investments correctly for retirement planning and funding. A common rule of thumb is a withdraw rate from investments of 3 to 5 percent annually. This needs to be reviewed periodically.
It’s vital to chunk investments toward goals. Look at a portion of your portfolio as money needed in the next one to five years and invest accordingly.
Next, look at your five to fifteen year time horizon and then your over-fifteen year segment of funds. This helps reduce shorter-term risks, yet hedges against longevity and inflation eroding your purchasing power.
The true million-dollar question is how to find your path to retirement. Each path is different, with unique twists and turns to be navigated step-by-step, carefully and continually.