Most of us vastly underestimate the percentage of income we’ll need. Here’s how to make sure you get that number right.
This is the question everyone wants to have answered as they save, work and plan for their retirement: How much money will I need, when I finally stop working and retire? The typical approach of asking what percentage of your final salary you’ll need is not quite right, says The Wall Street Journal in the article “How Much Money Will You Really Spend in Retirement? Probably a Lot More Than You Think.”
This is a complex question and one that requires more knowledge than most people have, even professionals. Just imagine the data you need:
Try figuring this out on your own. How can you know all or any of these items?
To better understand how people approach this question, hundreds of people were invited to a research lab and asked how much of their salary they thought they would need in retirement. The answer most people gave was about 70%. The people were then asked how they got to that number. The answer, not surprisingly, was they had heard it somewhere.
To dig in deeper, another group of participants was asked specific questions about how they wanted to enjoy their time during retirement. Based on this information, the cost of these activities was calculated and then a calculation was done to find out what percentage of their salary they would need to support the type of life they imagined they would have in retirement.
The answer was 130%. That meant their savings rates would have to double for a successful retirement.
How is this possible? Working is cheap. You’re not spending a lot because you’re busy working. The company pays for your health insurance, life insurance and there’s even a breakroom stocked with great coffee and snacks.
When you retire, you’re spending money you would not be spending while you are working. Two big vacations a year, recreational activities and dining out more all add up quickly. So how can you plan successfully for the retirement lifestyle you want?
Think (realistically) about the costs of the activities you have in mind and get as detailed as you can. Once you know how much you want to spend, add them up. Use a spreadsheet or a notepad, but this exercise will give you more information than the simple conventional wisdom of 70%.
Now that you know how much money your dream retirement will require, start to plan what you need to do to get there or adjust your dream retirement. Work backwards to figure out how much risk you are comfortable with your investment portfolios and how much cutting back you’re willing to do in your pre-retirement life for your dream retirement. It’s better to know, years in advance, than to be brought up short and have your retirement dreams come crashing down.
Reference: The Wall Street Journal (Sep. 3, 2018) “How Much Money Will You Really Spend in Retirement? Probably a Lot More Than You Think”
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