Ever have those long, hard days at work and find yourself suddenly day dreaming about your retirement? If you are like me that dream is often short lived when you look at your savings and realize you can only afford to be retired for about a year.
Did you know that millennials earn about 20% less than their parents’ generation and are only saving about 8% of their salaries for retirement? In fact, nearly half of millennials expect to work part time during retirement! Perhaps the problem is that millennials don’t know how much they should save for retirement, when they should start saving, and how much of their income should be allocated towards retirement.
If you were to ask the experts about how much you should save for retirement, they would say “as much as you can”. But that’s not very helpful when you are trying to budget for those glorious days when you no longer have to work the 9-5 grind. Unfortunately, no one can provide a clear answer as to how much you need to save for retirement, the answer depends on what kind of retirement you want to have.
Experts say that in order to retire you need 25X your annual expenses in savings/investments. For example if your expenses totalled $40,000/year, you would need $1,000,000 in savings to retire. This does not mean that having 1 million dollars under your mattress will sustain your retirement. Rather this 1 million dollars in an investment account would allow you to live off the portfolio in a way that would sustain your yearly expenses. So the first step in determining how much you need to save for retirement is to identify the expected total of your expenses in 1 year during your retirement. As a young millennial it may be difficult to look that far into the future and estimate how much we will spend during retirement. If you want to live the lifestyle that you currently live, start by using your current annual expenses as your baseline. Again, it comes down to your expectations for retirement. Once you have calculated how much you anticipate spending in 1 year of retirement, multiply that number by 25 and that is how much you need to retire.
If you have calculated that number you are probably thinking one of two things. You may be thinking okay, that’s not too bad, or you are cursing my name and are overwhelmed by what seems like an impossible number to achieve. But don’t fret my friend, especially if you are a millennial and years away from retirement. You still have time! So when and how much should you save? You should start saving as soon as you can, like today. How long you need to save for depends on how much you are willing to save which in other words is your savings rate. Your savings rate is the amount of money you have left over after taxes and expenses divided by your after-tax income. As per our example if you earn $50,000 after tax and spend $40,000 in expenses your savings rate would be 20% (50,000 subtract 40,000 divided by 50,000). In order to save $1,000,000 for retirement (25X rule with $40,000 in expenses), with an expected 5% return on investment, you would need to save 20% of this income for approximately 32 years.
So what’s the moral of the story? In order to comfortably retire you need to identify the following:
- Your expected expenses for 1 year of retirement and then multiply by 25 and that shows you how much you need to save for retirements
- Calculate your savings rate
- Use the graph above to show you how long you need to save for using your savings rate.
And if you are wondering which investments accounts you should use for your savings well you will just have to wait and see!
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