It was another relaxing day. While sipping my coffee, I talked to my wife about life in general. We discussed whether we were doing well in achieving our career goals or whether extra efforts were necessary. The conversation was long but gratifying. We were able to put pieces together and devise a plan to achieve what we had been craving as professionals. A thought struck me at that moment: What about our financial plan? When we retire, how much money will we need? What do we want from our retirement, and if we are on track or not?
It has always seemed to me that I knew what I wanted. I should have been able to calculate a dollar amount easily. My brain should have used a fast way of thinking, and just like that, I should have known the total. Yet there I was, dumbfounded, leaning back in a chair, deep in thought. I knew I had to use my slow thinking (Refer: Thinking Fast & Slow by Daniel Kahneman). It’s not easy to think about what you will need in the future, how much it will cost, and by what percentage you have to increase your wealth each year.
Despite not being my very first step, I assert that this is the very first thing we all should do. The goal should be to determine how much you’ll need in retirement to live comfortably.
To see if I was the only one who couldn’t come up with that number, I went testing waters. On my regular group call (No thanks to Covid) with friends, I posted that question. They are all doing well professionally and are good investors, but no one answered my question. In another group call with school friends, I posted the same question, and no astonishments there as well. No matter where I asked and whom I asked, No one gave me a final $ amount.
Today I know my number & more importantly, I know I need to grow my wealth (Wealth is not annual income) by 10% every year. But I am want to target 12%. The target may look small, but history suggests it’s not an easy task. (Refer: Historical Market Returns Google Search). I need to beat the market returns. In his book “A Random Walk Down Wall Street,” Burton Malkiel pointed out why investing in an S&P index fund is better than trying to beat the market.
The bigger question is, how did I manage to come up with a number? The goal will be different for everyone, and one size fits all won’t make any sense. So everyone needs to plan it meticulously. In the book ” The Psychology of Money.” I found a fascinating chapter, “Never Enough.” Morgan Housel explained, “The hardest financial skill is getting the goalpost to stop moving.” So I took the cue and started from Goal Post.
“Enough doesn’t mean you have to go without necessities. Enough means you know when to avoid doing something you will regret. Many things are not worth the risk, regardless of the gains. Reputation, Freedom, Family & Friends, Love & Happiness should be considered”. – by Morgan Housel.
It’s easier said than done. I am not a certified financial planner, and everyone should seek proper guidance. But I am here to explain my process. If you search online, one crucial factor that decides everything is “how much would you need in retirement per month.” Essentially every online retirement planner assumes we know the following details:
- Annual Income – But am I not going to keep working towards our goal post?
- Dollar Saving’s per month – This is coupled tightly with Annual Income.
- Monthly Retirement Spending -This has tormented me the most. How can I get it?
I started by asking myself, how much do I need today every month. I have expenses like ChildCare, Home Loan, and Car Loan, which might not be there in the future, but assuredly will be replaced by Health Care & Travelling. For me, goalpost means a guarantee that I would not need to work after age 55. I might work If I wish to, but it should not be an obligation. I intend to get income from my investments as dividends or windfall after selling outright winners. So If I can come up with a number for today, I should be able to extrapolate it to get a number for the future. But taxes & inflation are hidden atrocities, and I need to account for them as well.
- Step 1: How much I spent last year and divided that by 12. Assume 4000 $.
- Step 2: Added any foresee monthly spending in the near term to a monthly expense. Assume I want a car and a fun family vacation every year. 4000 + 1000 = 5,000 $
- Step 3: Add another 30% for margin of safety. 5000*1.30 = 6,500 $.
- Step 4: Multiplied that number by 12 for the yearly spending. 6500 * 12 is 78000$
- Step 5: I want to get this annual income as dividends. It needs to be at least 2% of my total wealth portfolio. (78000 * 100)/2 = 3.9 Million Dollars.
With this process, I came up with a number with which I can comfortably retire today. Compared with monthly income, Monthly spending in Step 3 would suggest how hard I need to work for this goal.
The dollar worth will diminish in 20 years because of inflation. I need to adjust the target keeping taxes and inflation in mind. So I would need 3.90 Million dollars adjusted for inflation. Technically this figure includes Stocks, 401K, Roth IRA, HSA & all other investments. The final step is to know how much I need to increase my wealth yearly to get this inflation tax-adjusted magical number. For this, I used excel. Download & play with it here.
This excel is vague, and I don’t expect it to be even 60% correct, but it should give me a ballpark estimate and a goal. Before I put down the growth number, let’s look at all input fields. C3 is inflation which historically, is less than three, but I will use 3%. C4 is how much I am going to invest every year. C5 is by how much I will increase my investment every year. C6 is the initial investment and C7 tax rate, which I conveniently took 33%.
By playing with the expected growth number in C2, using 1.1 for 10%, I get some numbers in cells E34, K34 & L34. Where cell number E34 is what I expect in my investment account in the year 2043. K34 is what’s left after paying taxes & L34 is what that many dollar’s worth today. Now I know that I need to grow my income by 5% every year to save & invest 5% more per year. If I need to accomplish my goal of having 5 million dollars in the bank account or inflation tax-adjusted 1.6 Million dollars, I need to target and increase my wealth by 10% every year.
As I pointed out earlier, this excel is not perfect. Far from it. It is just my attempt to come up with a template that can help me clarify two things. First, How much money do I need for retirement? Secondly, How much growth should I expect from the stock markets. That can help me evaluate risk vs. rewards in every investment. If my goal is just 10%, implying doubling money every seven years (Rule of 72), I can avoid many risky stocks. But more on that later.
If the post helps you realize your number and personal rate of return you would need to achieve to fulfill goals or at least get you started thinking about it, I will consider my job well done.