How Much Money Do I Need?Posted on August 14th, 2010 William 1 comment
How much money do I need?
There are really two questions here: how much money will I need to live on after I retire, and how much do I need to save now to meet that goal? If you start saving early and plan correctly, most of the money you'll live on in retirement will actually come from compound interest, rather than being money you put away yourself.
Once you retire, you might need less money...or you might need more! Consider these factors..
How much will health insurance cost? If you're not working, health insurance can be very expensive. Older people tend to require more prescription medicines and expensive surgeries; you should plan for your costs to increase.
How will your habits change? You might save money on gas once you're no longer driving to work; you might even stop driving altogether, doing away entirely with the expense of a car. On the other hand, you might decide to take up traveling..
How long do you expect to live? If you retire early, your savings will need to last for a long time, especially after you factor in inflation. People are living much longer these days; you'll likely want to plan on having money to last for several decades.
Suppose you decide that you can live on the same amount of money you're making now; how big of a nest egg do you need to provide that much money, adjusted for inflation, indefinitely? This really depends on how aggressively you plan to invest after retirement; if your retirement fund is making 15% interest, you’ll need a lot less than if it’s making 5%...but you’ll obviously be taking a bigger risk. A balanced retirement fund consisting of a mix of investments that return an average 10% per year would let you live indefinitely on 12 years’ salary (the extra 20% going back into the fund to counteract inflation).
Where will I get 12 year’s salary? I can barely save any money now!
You’re not alone; people our age, on average, have unprecedented levels of debt and very little in savings. The important thing is to start as soon as possible. Remember, $1 invested at 7.2% interest now will return $4 in twenty years. If you are 25 years old and invest 17% of your salary each year for the next 25 years (ignoring raises and inflation), you’ll have over 12 years’ salary at age 50. Saving a full 20% will give you over 14 years’ salary.
I can’t save 20% of my salary!
Spending is always much easier than saving. That’s why it’s important to do two things:
Have the money automatically deducted from your paycheck, so you never have a chance to spend it. This is generally called "pay yourself first" and is the most effective way to save money.
Find ways to supplement your income; just because you're retired doesn't mean you can't bring in some extra money!
We’ll discuss ways to do both of these in other articles.
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