What’s Your Number
Words by: Bryon Gragg
Published March/April 2012
“What’s your number” is a phrase that can have a multitude of meanings; in this column,we aren’t discussing telephone numbers,cholesterol numbers, calories or weightlifting ability. Reflecting a bit, a more appropriate title may have been “What are your numbers?” From a financial planning perspective, there are many numbers involved, but some are more important than others.
We refer to your “number” as the amount of money you will need to retire comfortably. Obviously your number will change over time and it is imperative to revisit it at least annually to ensure you are on the right track. So how is your number determined? A simple formula can help establish it; the starting point is the amount of retirement income to support your lifestyle. This is determined by taking your current lifestyle expenditures and adjusting for expected changes. Will your mortgage be paid off by the time you retire? Will your children be out of college? What are your retirement goals?
There are basically three stages to retirement: the go-go years, the slow-go years and the no-go years. Many people spend the first several years of retirement traveling, having fun and being constantly on the go. During the go-go years, your actual retirement income needs may be greater than when you were working. The next phase is the period during which travel is reduced and a closer-to-home attitude is adopted. The no-go years are the later years of retirement that are spent at home or in an assisted living facility.
Once we have the amount of retirement income needed, we convert that to the amount it will be in the future when you retire. As an example, let’s go back 30 years to 1982 when a gallon of gas was 91 cents, a postage stamp was 20 cents, the average new car price was $7,983 and the average new house was $82,200. Obviously, these are more expensive now and will be so in the future. By taking the number of years until retirement,the projected inflation rate and the amount of retirement income needed, you can determine the amount of retirement income in future dollars. So, if that’s where you need to be, how do you get there?
The next step is to determine what financial assets you currently have set aside for retirement. This number plus expected additional contributions over time and using a reasonable projected growth rate will give you the amount of financial assets expected at retirement. We refer to this as your pile, the projected total amount of money you will have when you retire.
So now that you have your pile at your retirement date, what’s next? The pile needs to be large enough to last you through the go-go, the slow-go and the no-go years. Retirement can easily last 20 to 30 years so you can only withdraw a certain percentage each year in order to make sure you don’t run out of money. There are various opinions on which initial withdrawal rate is safe. For initial planning purposes a withdrawal rate of 4-5 percent is adequate. It is best to be conservative and save more money than you think you’ll need.
By taking your pile and multiplying it by the withdrawal rate, you have the amount of retirement income available to spend from your investments or retirement plan. This number could be increased by such items as pension income and Social Security benefits. One caveat: Given the state of the Social Security system, we generally don’t include it in calculations for younger individuals, just to be on the safe side. So now you have the number that is needed in retirement to fund your lifestyle and the number that is projected to be available. Chances are they won’t be equal. If the amount projected to have at retirement is greater than the amount you need, congratulations. If the amount projected is less than the amount needed, it is time to determine what you have to do to get on track. That’s a topic for a future column.
These are relatively simple computations done with a financial calculator but keep in mind the adage “garbage in, garbage out.” If you use unreasonable assumptions, you could be setting yourself up for financial failure. It is best to be conservative and have more than you need
when you get there.