This is a little math-heavy, but I'll break it down for all our sakes.
- Determine how much money you think you need (annually) in order to retire in today's terms.
- Calculate what that amounts to in future dollars. (Here's how I do this: find a good savings/investment calculator online, enter the aforementioned dollar amount in the initial investment field, make sure future deposits equal $0, enter an estimated inflation rate in the APY/interest rate section ((I use 3-4%)), make sure the compounding rate is annual, enter the number of years until you want to retire, and hit submit.)
- Whew! Now that that's done, you know what your annual income needs to be to keep your standard of living in x number of years. Now take that number and divide it by the percentage of interest on your nest egg you want to live on. This instruction will be more clear in the example, so keep reading.
- Arrive at the amount you need to have invested by the time you retire.
How to accumulate that amount of money is for a future post. For now it's just good to know what we're aiming for.
Our future nest egg-- a real life example
Of course, this number is very much subject to change, but here goes. First, you need to know that as part of our future financial plan we will have already paid off our house by the time we retire and plan to have no consumer debts whatsoever.
- We've set a tentative goal for our income at $40k/year. Without a house payment, car payment, or anything else, this should give us plenty of fun money and give-away money to use as we wish. Whatever vacations we want, etc.
- I've plugged this number into a 'savings calculator' and come up with these figures: if we were to retire in 30 years (that will put us at 50-ish), today's $40k will be worth $100-130k. So, really, our income goal is actually 100-130k if we want the standard of living 40k will get us now.
- Now the fun begins. If we want this money to last until we die, even if we're 300 years old when we do, we need to live on the interest. Plus, we want this money to keep growing so that we stay ahead of inflation. If we invest in growth-stock mutual funds averaging 12% and inflation is calculated at 4%, we need to live off of the interest minus inflation (12-4), or 8% of our total nest egg. 100k is a nice, round number, so taking 100,000/.08=1.25million. This approach will have the added benefit of leaving a nice big inheritance to our children or beneficiaries in addition to our house, etc.
- We need to accumulate $1,250,000 over the next 30 years to acheive our retirement goal.
So there you have it. Yes, I know that this formula is highly simplified, but for those of you who don't know where to start it should at least give you a point of reference. I'm interested in knowing what kind of numbers you have come up with. Comment and let me know!