The previous few chapters of The Bogleheads’ Guide to Investing covered the types of investments available to an investor, but Chapter 6 focuses on something equally important: How to come up with an estimate of how much you need to save for your retirement.
The Bogleheads examine nine different factors when calculating this value. They are:
- The amount you currently save
- Current age
- Planned retirement age – This varies from person to person, but a standard estimate can be based on the age at which you would become eligible for Social Security benefits or a pension (if you are eligible for one).
- Number of years you will live off the retirement account (based on life expectancy) – The book suggests a figure between 25 (standard) to 30 (conservative estimate based on the trend of longer life expectancies of the general population) years for this number.
- Do you want to leave a legacy or just ensure that you have enough to cover your entire retirement? – The Bogleheads stress that the higher priority should go toward funding your own retirement first before any thought should go into leaving something behind for your heirs.
- Expected rate of return on your investments – This is calculated according to a 30-year market forecast chart available at Portfolio Solutions using a current breakdown of your investment holdings. Using the values from the “With 3% Inflation” column, multiply the percentage of your current retirement portfolio invested in each type of investment by the corresponding value from the chart. Add all of your individual line results together to arrive at your total estimated rate of return for your portfolio.
- Rate of inflation – 3%-4% is a good estimate. Inflation must be factored into any retirement savings calculation otherwise you may wind up short of the amount needed.
- Expected inheritances prior to retirement – According to the book, you should not rely on an inheritance to bail you out if you don’t set aside enough for your retirement. Plan to save enough without the expected inheritance, and if it should indeed come your way, treat it as a windfall, not the linchpin of your retirement strategy.
- Other sources of income during retirement (e.g. pensions, Social Security, part-time work, etc.)
Once you are armed with the data above, you can easily plug those numbers into a variety of retirement savings calculators to check if you are on track for a comfortable, independent retirement. It is important to note that the equations and formulas these calculators use to determine your retirement savings goals can vary quite a lot. Some will allow you to input each of the nine factors while others automatically assign a standard value or guess to one more of the factors such as rate of inflation or number of years in retirement.
Here are a few sites hosting free online retirement calculators:
The chapter wraps up with a set of six tables that show how much you need to accumulate by retirement age per $1000 of retirement income desired annually assuming 30 years of retirement and an inflation rate of 3%. You select a chart to use based on how many years you have until retirement – 5, 10, 15, 20, 25, or 30 – and then choose your multiplier based on your expected annual rate of return on your investments – 5%, 6%, 7%, or 8%.
The estimated rates of return in these charts and in the 30-year market forecast charts may appear to be conservatively low, but the Bogleheads warn against falling victim to recency bias (“projecting recent events into the future”). While certain types of assets may perform very well in the past one or two years, there is no guarantee that they will do so consistently over the next 5 to 30 years. An observed market force called reversion to the mean (RTM) indicates that most assets cycle through periods of overperformance and underperformance, and that outstanding recent past performance is not an indicator or guarantee of continued success when it comes to investments.
Overall, I felt that this chapter provided a very good breakdown of the data that each individual needs in order to calculate their actual retirement savings needs. I especially appreciated the tables that were provided to calculate the rate of return on my investments and the quick and dirty ballpark figure tables at the end of the chapter for estimating the total amount I would need at retirement.
Thanks to this chapter, I now know that I need to save a mere $1,547,910 (based on a 7% annual rate of return) in order to retire in 30 years and withdraw $35,000 per year from my retirement savings for another 30 years.
Now I just need to visit the Bloomberg calculator to see if I’m on track to meet that goal.