Friday, July 27, 2007

How Will I Know I Have Saved Enough?

There is a great discussion in the blogosphere about saving or not saving too much. Basically, it boils down to this. One camp is concerned about over saving and foregoing too much early in life. The other camp is not concerned as much since any excess saving can lead to earlier retirement or a better lifestyle later in life.

Here's how I think about whether I have saved enough:

As background, my plan for retirement is to live on 80% of my current income. Doing so shouldn't be an issue, since we currently save 20% of our income.

Based on an article by Charles J. Farrell, J.D., LL.M., the minimum amount one should save is 12 times one's income just before retirement if one retires at 65. Assuming 5% real return and withdrawing 5% each year will produce 60% of pre-retirement. Social Security payments are expected to provide the other 20%

However, I plan to retire in my 40s. Therefore, the savings ratio will be higher. I will have "enough" at minimum of 16 to 18 times my salary just before retirement. Again assuming a 5% real return, a 5% withdrawal rate will produce 80-90% of pre-retirement income. However, I have increased my target to 20 times my income just before retirement. My financial advisor ran a Monte Carlo simulation that convinced me 20 times was "enough" when retiring in my 40s.

My savings ratio is 15.2 as of June 30, 2007 and I am trying to achieve 16.5 by end of this year. When I reach a savings ratio of 20, I will begin my "retirement phase" of life :-)

For more on Reaping the Rewards , check back every Saturday for a new segment.

This is not financial advice. Please consult a professional advisor.

Copyright © 2007 Achievement Catalyst, LLC


traineeinvestor said...

Glad to see you had a proper simulation done and have added a margin for safety.

Retirement plans are potentially very vulnerable to losses or below average returns in their early years. When capital is being drawn down to fund living expenses it is very hard if not impossible to recover from early losses/below average returns. Above average returns later on will seldom be enough to recover the plan.

Raj said...

I am afraid I am one of the don't forgoe to much now to save camp because even if you retire early at 40, you have still sacrificed the prime of your youth for earning and saving money and you can't really enjoy the same way after 40 I think...

Super Saver said...

@ Trainee Investor,

Excellent point about the major risk being losses during the first few years of retirement. In the Monte Carlo simulation that my financial advisor did, the majority of failures were due to signficant investment losses in the first few years.

@ Raj,

Thanks for your comment.

To your point, each person needs to decide what the right balance is for "living today" vs. "living tomorrow." On your second point, the people I know over 40 seem to enjoy life as much or more as they did in their youth :-)