In part 1 I talked about having the right attitude about saving – viewing saving as an exciting opportunity to build your personal “freedom fund”. In Part 2, I discussed the proper time to start saving so that you can allow compound interest to do the heaving lifting for you. Specifically, I demonstrated with charts how saving in your twenties could allow you to have $1M at age 65 by saving only $25,000 and investing those funds in a stock market index fund.
In Part 3, I want to discuss how your savings rate (i.e. percentage of income saved) dictates how long you will have to work before you can fully retire. You will recall from earlier articles that I use the 4% rule for determining when someone has saved enough money to retire. According to the 4% rule, you may retire when you have saved 25 times your annual expenses. Stated another way, if you multiply 4% x your nest egg, the result of that equation must be sufficient to support your annual retirement needs. Example: 4% x $1M= $40,000. $40,000 x 25= $1M.
So when do YOU want to retire??
Okay, now that we have the basic math out of the way, when do you want to retire? Do you have a job that you love so much you can’t wait for Monday morning and don’t want to go home at night? If so, awesome!!! This article may not do much for you. But for the other 99% of you, keep reading.
In our society we throw around financial rules of thumb like the 4% rule and the need to save 10% of your annual income to have enough money to retire someday. But when is someday? Do you want to quit your career early so that you’ll have time to pursue charitable causes, hobbies, or international travel? If so, this article will be very helpful!
10% Savings Rate
Let’s start with an analysis of the standard 10% retirement savings recommendation. And let’s assume that you invest 60% of your money in the Total U.S. Stock Index Fund and 40% in Intermediate U.S. Bonds (I use this for illustration purposes only – this is not my personal investment mix, which you can read about here). How long would you have to work before you could retire without the need to earn additional money? Take a look:
25% Savings Rate
As you can see from the graph, if you save 10% of your annual income you can retire after approximately 46-47 years of employment or about age 66-67. That may be fine, if you really love your work and want to stay at it as long as possible, but probably isn’t ideal for the person with a long bucket list they’re itching to get to while they feel healthy and fit. So, let’s try another one. How about saving 25% of your annual income with the 60/40 stock/bond split? What will that do? Here are the results:
As you can see, a 25% savings rate allows you to retire after between 23-32 years of work — or between the ages of 43 and 52. Why such a wide range? The range is so great due to the overall volatility of a 60/40 Total U.S. Stock Market/Intermediate Bond investment portfolio. Using my own personal investing style, the range with a 25% savings rate would be much tighter: 21-25 years — or ages 42-45.
50% Savings Rate
Now, what if you really want to retire as early as possible because you have a mile long list of dreams you want to pursue? Well, if you can avoid the typical “script” I discussed in Part 2 and commit to saving 50% of your income before you go out and make decisions on houses, cars, dining out, clothing, and entertainment, you can retire much earlier. Take a look at the chart:
Wow! That’s a short career — 13-20 years of work — or between ages 33-40. It is achievable if you have the discipline to pay yourself first before building your family budget! If you use a more diversified portfolio similar to mine, the time range is much more precise: 10-14 years or ages 30-34!
As I’ve said before, investing and retirement planning is a personal decision and “You’ve Got to Be You“. Which savings percentage is right for you? Is it 10%, 50%, or somewhere in between? Regardless, I find that the data is very helpful so that you know the effect of your savings decisions.
If you want to try some different percentages and portfolio choices, head on over to portfoliocharts.com — my favorite investing data website — and run a few examples for yourself!
Happy Easter everyone!