I recently read an article by one financial expert who said that in order to retire, you should have 12 times your annual salary in the bank. In other words, if you are earning $60,000 a year, you should have $720,000 stashed away. Another financial expert said you shouldn’t retire unless you have 20 times your annual salary in savings. This means that instead of $720,000 you would need $1,200,000 stashed away.
Another way to calculate retirement savings
Some financial gurus are now suggesting an alternate way to look at savings for retirement. It is that instead of focusing on your income, you should focus on your living expenses. Now, I understand that many people are living from paycheck to paycheck so that their expenses and income are about the same. Of course, this is not true for everybody. Plus, it does not take into consideration the fact that you’ll most likely scale back your lifestyle when you retire.
Post retirement expenses
To follow this advice means you will need to start estimating your post-retirement expenses. You could start by estimating your expenses for a typical month and then multiply by 12 to determine how much you will need per year. Next, you will need to “guesstimate” what kind of returns you can expect to get from your investments. While it really requires a crystal ball to guess what kind of return to expect, let’s say 4% for this example. This means 4% returns after inflation is accounted for probably means nominal returns of 7%. Next, you’ll need to multiply your annual expenses by 25x (1/.04=25). Or if you want to estimate on the conservative side and think you’ll only be able to get a 3% return, you’ll need to multiply your expenses by 33 times.
At this point, it’s very difficult to estimate what your Social Security benefits will be. However, you should try to factor these in as well as any pension payments you will have coming. You can use these income streams to offset some of your expenses and these should be subtracted before you calculate your multiplier.
If you do this math, how do you feel about your number? Does it look big and scary? Or do you feel that you’re well on your way to achieving it? If it does look scary, you will need to find ways to increase your savings, whether it’s by taking a second job or by saving a larger percentage of your salary. If you’re typical, you should be able to cut your living expenses by at least 20% – which doesn’t require a huge sacrifice – then use the money you free up to save more.
How to cut those expenses
If you haven’t done this already, you need to do is start tracking your expenses so you’ll know where your money is going. Once you’ve done this for, say, a month, you will need to create a budget. As noted above, your overall goal might be to trim your expenses by maybe 20%. Places to look where you should be able to make cuts include food, entertainment, clothing, transportation and credit cards. While credit cards is not exactly a category, you should take a good luck at how you’re using those cards, the interest you’re paying and any areas where you could pay cash – which would reduce your interest costs. If you have multiple cards, you might consider transferring all your balances to a single credit card that has a lower interest rate and comes with a zero balance transfer rate.
If you’re well on your way
On the other hand, it is you feel you’re well on your way to achieving your magic number, congratulations. All you will need to do, as they used to say, is just keep on keeping on.