How Big is Your Nest Egg?

30 Apr How Big is Your Nest Egg?


Knowing What you Need for Retirement

Many people ask how much money they need to save for retirement. This is an intimidating topic for most, but it doesn’t have to be that hard. Here’s how to find out if you will be comfortable in retirement.

Growing Your Nest Egg

First, ask yourself what income you can comfortably live on in today’s dollars when you retire. If you had no debt, how much money would you need to live? Make sure you are on track to eliminate debt, and have an established time line to be debt free.

Then calculate the future value of your investments needed to meet your current monthly expenses with 6% of the nest egg. You can do this with an investment calculator or with the help of a retirement planner. Here’s why 6% is important: When you invest for the long term you should expect a 10% average return on your investments with an aggressive portfolio. The stock market has averaged more than 10% over time, even including the Great Depression so this is not an unreasonable expectation. At retirement you should still expect 10% on your investments (on average – some years will be less, some will be more as the market fluctuates). If you receive 10% income in a year, and inflation reduces the value of your money by 4%, you would effectively be living on 6% of your investment portfolio. So, when 6% of your retirement portfolio equals your living expenses, you are ready to retire.

The numbers can get confusing but if you understand the general principles, you can begin to plan for the future. Simply knowing what your nest egg needs to be gives you a goal. Once you have a goal you can lay out a plan to achieve the goal.

2 Comments
  • joetaxpayerblog
    Posted at 03:43h, 30 April

    Any reference to “the number” tends to use 4% as the safe withdrawal rate. This from the Trinity Study, and multiple money authors, including Scott Burns. Your 6% figure would work if the market had no volatility, returning precisely 10% each year, but it seems 4% is used to be sure one can survive the periods of a down market.
    Joe

  • Matt Wegner
    Posted at 21:48h, 30 April

    Excellent point, Joe, and a great opportunity for discussion. I used 10% return to be somewhat conservative from the start, even though many experts like to use 12%.

    Living on 4% of your nest egg is more conservative than the 6% I recommended. The right number to use depends a little on what your nest egg will be worth at the time you retire and your risk tolerance. If you’re going to be a multi-millionaire you probably won’t have to worry too much about the ups and downs of the market if you invest well. When the market drops, your return will be less than 10% and the retirement fund will drop in value as you draw from it. However, when the market is up, the return is higher than 10% and you gain money (in effect breaking even). On average you break even each year, especially if you hold out more than five years.

    All in all, if you use 4% as your rule of thumb and can make it work, you’ll be even better off throughout your retirement period. Whichever number you use, the important thing is to understand the risks and rewards of all options, and make informed decisions.