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Why do you invest? For most of us the answer is straightforward – we invest to accumulate assets to meet a future goal, like the cost of a child’s education or our own retirement. Saving for retirement is a near-universal objective, but after the market volatility of the past decade, you may be questioning some of the assumptions you’ve held about saving for retirement, including how much money to invest and where to invest it.

So let’s start with a basic question: How do you know how much to invest for a big goal such as retirement that may be many years down the road? This is the million-dollar question—literally and figuratively—for financial planners. Getting to the right number often means the difference between a comfortable retirement spent traveling and enjoying life and one where you’re forced to worry whether your nest egg is going to last at least as long as you do.

On the surface, this question shouldn’t be difficult to answer even 30 years from retirement. One of the first things I learned when studying to become a financial planner was the time value of money (TVM) and a set of handy formulas for calculating the present-day contributions needed to reach future goals. Thanks to the Internet, you don’t have to learn how to use the HP 12c like I did (though I’ll give a shout-out to anyone who still has a vintage 12C from 1981, which incidentally, Hewlett Packard claims is the oldest consumer electronic device in continuous use for 30 years!).

There are several decent basic retirement calculators online, but I like this one courtesy of the Financial Industry Regulatory Authority (FINRA). Just plug in a few key assumptions, such as:

  • 30 years to retirement
  • 9% return (that’s the historical average from 1926-2010 for a 70% stock / 30% bond allocation – but keep in mind that a consistent rate of return of 9% per year over a shorter time period is unrealistic)
  • 4% inflation (that’s a little higher than the historical average, but you’ve probably noticed the cost of food and health care rising, both of which you’ll need in retirement, so let’s be conservative.)

…and voilà. Let’s say you have $400,000 already invested for retirement and your goal is to have $150,000 annually (after-tax, in today’s dollars) when you retire. The calculator says you need to save about $18,000/year for the next 30 years to meet your retirement goal. If that sounds daunting, well then, it’s best to know now. If it doesn’t, congratulations—you’re on the right track.

But wait a second. Did you notice that 70/30 stock/bond asset allocation assumption I slipped in above? Where did that come from, and why is it important? Stay tuned for part 2, where we’ll answer that question and talk about how asset allocation plays into investing for retirement.

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Disclaimer: The assumed rate of return and other assumptions included in the retirement calculator example above are strictly for illustrative purposes, should not be construed as investment advice and are not representative of any actual performance outcome. Actual results will vary and investors should consider their specific situations when making an investment decision.

Source: Investing for Retirement Part I: Getting the Number Right