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Saving for Retirement

After writing a bit about The Number, I thought further discussion of this was in order. First, there's much debate on the post-retirement income needed. A frugal, extreme saver may put away 30% of their gross income. Separately, they may save for their children's college, and likely, paying down a mortgage. This is certainly the extreme example of people who may not even need to replace 40% of their gross income at retirement.

Others, who lived on 85% (just the 15% savings rate I recommend) find that once retired, they now have time to pursue hobbies or travel and need well over 100% of their preretirement income. For this article, I'll figure that 80% is the goal.

Much analysis has been done surrounding the 'safe withdrawal rate', i.e. the percent you may withdraw from a diversified portfolio with an expectation that you will not draw the money down to an unsafe level. The final number that most agree upon is 4%. The math and the Monte Carlo simulations may make your head spin, but the approach can be simplified. If you withdraw 4%, and assume a 3% inflation rate (remember, your withdrawals will need to increase over time, as even 3% inflation can reduce your purchasing power by half over a 24 year period) the market would need to give you a 7% return to meet these assumptions. You may object here, thinking that the stock market has averaged 10% over the last century, why should we assume anything different now? Well, in any given year the market may rise, sometimes far more than 10%, or it may drop. 2000-2002 saw three years of 10%+ drops each year. The 4% withdrawal rate lets you spend an amount each year that will survive such periods. Another site you may want to read is called The Retire Early Homepage, this site offers a series of papers devoted to this topic. Another article worth reading is by Scott Burns regarding the Trinity Study.

Now that we've arrived at the 4% figure, and a target replacement income of 80%, this works out to a goal of having 20 times your income invested for retirement. You should adjust this goal up (if you want to travel the world or have expensive hobbies) or down (if you have a good pension plan, or inheritance you can count on). Either way, this is a starting point for planning one's future, not a rigid plan. See the spreadsheet page where you can change the numbers to reflect your own situation or download a copy to your computer. If you have any comment or ideas to change this, I'm happy to hear from you. Please use the link to my blog and send a comment from there.