“Enough” is a tough concept to answer for each person, but extremely important to define for an person’s financial goals. Remember the role of money is only to give you a happy, satisfying life. For some people “enough” means a yacht with two helicopter pads (because with just one they’d be unhappy), though I’d suggest they may have lost their perspective on what it takes to make them happy. This concept is so critical that John Bogle, the founder of Vanguard and the father of index investing, used it as the name of his book.
There is a classic bit of financial wisdom, that totally misses this point. It states you figure out your needed retirement income as a percentage of your current income, typically about 75%. This is overly simplified, foolish, and sends the wrong message. Think if you get a big raise late in your career, would you think, “Oh no, my retirement account is suddenly way underfunded!” Of course not. Further, your expenses in retirement are completely different from those pre-retirement. Instead, you want to calculate what you need for enough. This is obviously different for each person, but I suggest determining your happiness needs in three categories.
1. Lifetime income. Hopefully you’ve gone through the budgeting exercise for your current expenses. For your retirement income needs, you should go through this again, except for retirement life. Your categories will undoubtedly change quite a bit. If you’re retiring before Medicare age (65), or if you think the Government will screw this up before you get there, your medical insurance will be a significant expense. This is going up considerably every year, I’d budget at least $2000 per month for medical insurance and expenses. Also, perhaps you’re looking to travel more, golf more, eat out more, whatever, but you should have less expenses for that house mortgage (paid off!) and for kids. Again, you’re trying to define “enough” for you. Lets assume your monthly budget adds up to $5000 in today’s dollars. If you’re 30 and retiring at 65, with a 2.5% rate of inflation, this is
$5000 x 1.02535 = ~$12,000 per month
Once you’ve built this retirement monthly budget subtract your expected social security payment (also adjusted for inflation and if you are retiring after social security age AND you think it will actually still exist when you retire!) as well as any expected retirement pensions you might have. Multiply that number by 12 to get your yearly income need, it will look something like this:
12 x (Monthly budget -Social Security-Pensions) =Income need
e.g. 12 x ($12,000-$6000-$2000)= $48,000
Multiply this number by 25 and that is the rough amount you need to save to support the budget you developed, in this case $1,200,000, or roughly a little more than a million bucks. Multiplying by 25 follows the “4%” rule meaning you should be able to invest your money reasonably conservatively and withdraw 4% per year. This isn’t magic, and has a ton of assumptions, but is a decent best guess.
2. Home. I’m a believer that your retirement home should be mortgage free. If you are carrying a mortgage, that needs to go into the budget above, but let’s assume you are not continuing to carry debt in retirement. If you’re a homeowner now, generally your retirement home will be no more expensive, and possibly much less if you downsize. What I suggest is start dreaming about where you want to live, and what kind of house will make you happy. Use sites like Zillow to see what that house costs. Once again, adjust for inflation as we did for the budget above, and there is your number. If you really, really want another big purchase (like that second helicopter) include this cost also. But please, try not to believe you need a helicopter. Or two.
3. College. If you have kids not yet in college, and you believe it is your obligation to pay for it, this is the third big expense. I’ll have a separate post on saving for college, but in summary a good place to start is the current in-state tuition, room, and board where you live and multiply this by 1.5 for a teenager, 2.0 for a grade-schooler, and 3.0 for a baby. College inflation is pretty ridiculous. Thank your parents if they paid your way. Then multiply this by 4, for 4 years of college, and encourage your young one to finish in 4 years. Again, this could change a bunch if he/she really wants to go to that expensive private school, or grows into a world class volleyball player, but again, it’s a good guess. For example, where I live in Virginia, current tuition, room and board at UVa is $28,000. For a grade schooler, I’d plan on
$28,000 x 2.0 x 4.0 = $224,000
So now, just add them all up. For example, let’s say you figured out the $1.2 Million you need to generate the income you want, and figure you would like a $300k house, adjusted for inflation is ~$700k, and figure it will take a little over $200k to send your kid to college. The total then is ~$2.1 Million. This is your targeted net worth. That’s the minimum you will need, assuming all the assumptions above, and is a reasonable target for what you’ve determined as “enough”. Scary? It doesn’t have to be, and I’ll show you how to get there. If that’s too big a goal, you can make some adjustments to your future lifestyle, or decide to work a little in retirement or junior’s college choice. Also, if your goal is to retire prior to social security age, I’ll have a separate post on retiring early and how to define this need. The point is to have a definitive goal to shoot for that has some relationship back to what you feel you need.