So how do I know when I’ve saved enough for retirement? How do I know what the magic number is?
I am going to give you a simplified math formula, simplified in the sense that there are four steps.
So the first one is - take a look at your annual expenses, breaking them down into essential and discretionary. Make sure those expenses are allocated for, and you've thought through what’s going to fall off once you retire and what’s going to be added once you retire. You might have additional travel expenses, for example. So that’s step #1 - your annual expenses.
Step number two is to identify your fixed income sources. Often these are pensions. They could be Social Security, or they could be annuities. These provide a fixed income for you during your retirement years.
The third step is - subtract #2 from #1. Subtract your income sources from the expenses, and the answer you get there is the amount of income that your portfolio needs to generate for you.
Step number four - again simplified math, is to divide that number by 4%. So, let me give you an example. Let’s say your annual expenses are $200,000, and your fixed income source is $100,000. That gives you $100,000 you need to have from your portfolio. If you divide that by 4%, you need 2.5 million dollars to retire very comfortably. That would provide you with $100,000 investment income from your portfolio.
Now, why 4%? The rule of thumb is - at 4% you can take withdrawals against your portfolio, for your lifetime, and have a 99% chance of never running out of funds. We like the 4% rule very much here at Summit. We also allocate roughly 2.5-3% towards inflation. So our target returns should be in the neighborhood of about 7%. We feel like with that type of portfolio, we can generate enough income for you to take care of what your needs are, but provide you with some increase in the future because inflation is going to be something, maybe, we all reckon with.
The final point I would like to make regarding this simplified math solution is that it is just that - simple. Your situation may be much more complex. Be sure to meet with your financial professional and take a look at some of those areas of your life that may be a little more complicated than this. Your fixed income sources, for example, may not keep pace with inflation. Social Security often goes up very little compared to inflation. So factor that into your long-term investment planning for retirement.