“How much money do I need to retire?”
I can’t tell you how often I get that question from existing and prospective clients. It’s a reasonable thing to wonder about. Most of your retirement planning centers on the idea that you need a certain amount of money to retire comfortably - and that the figure you have in mind will remain stagnant throughout your retirement process.
A cursory look through Google search results will show you a wide range of answers. Some will say having a nest egg of somewhere between $1-1.5 million is sound advice. Other articles will tout an equation that multiplies your income by 10-12. However, the answer is much more complicated than a simple number or equation. To effectively calculate how much money you need to retire, you need to start with a retirement budget.
What's Your Cost of Living?
The first thing I encourage people to look at is their estimated cost of living during retirement. It’s smart to assume you’ll live similarly as you do now. Although, you might find your expenses fluctuate over the course of your retirement. On the front end, you may be doing more travelling, eating out, and enjoying being newly retired - which will increase spending. On the back end, you may end up spending more on unforeseen medical costs, which will also increase your spending.
To account for all of this, you can write out your current living expenses and build in a “buffer” amount for things like travel, long-term care and medical bills, etc. You may be surprised to find that the number is more reasonable than you imagined, but be careful. While many people assume they’ll spend less in retirement (which is the basis of an ever-popular “70-80% rule”), it’s easy to fall into the trap of overspending. To help avoid overspending, it’s wise to set a budget and cut any unnecessary expenses now while there’s still consistent income coming in.
Cutting down on expenses now can help you to remove unnecessary spending during retirement and refocus your spending on more enjoyable things - like travel or other unique experiences.
One easy way to ditch a few lifestyle costs is to work toward paying down debt now. Whether you’re still paying down your mortgage, loans, or credit card debt - focusing your energy on paying it down before you retire can be immensely helpful. You can also look to downsize your living space to either lower or eliminate your mortgage payments.
Don’t be afraid to think outside of the box, here. Just as you’d eliminate spending in a pre-retirement budget, getting serious about intentional spending post-retirement can help you get a handle on how much money you’ll actually need.
Don't Underestimate Medical Expenses
A common mistake people make is underestimating their medical expenses during retirement. While you may be healthy as a horse now, things inevitably crop up as we age. Fidelity Investments tracks retiree health care costs, and has been for over 10 years. Per this research, AARP reports that the average amount that a 65-year-old couple will spend on medical expenses during retirement is $240,000.
That number may seem unrealistically high. But the truth is, even if you face no out of the ordinary costs, your premiums, copayments, prescription drugs, hearing aids, glasses, and other every day medical costs can easily comprise most of that $240,000 quoted figure. Medicare will certainly help, but it’s coverage is still limited. So, to be safe - overestimate how much you’ll spend on medical costs. Then work this into your retirement budget. It’s always better to be over-prepared when it comes to your health.
When building a retirement budget, it’s tempting to use a cookie-cutter template. While this might work in order to get the ball rolling, it’s important to dig a little bit deeper and decide what kind of retirement you want. We live in an incredible time where the options for how you want to spend your retirement are truly endless. A few things to consider are:
How Much is Coming In?
In order to get a better understanding of how much you need to save for retirement, you’ll also need to know how much money you can count on coming in during your retired years. Two things you might consider as part of your retirement income are Social Security and a pension (if applicable).
To calculate how much money you’ll receive from the Social Security Administration, you can use an online calculator (like this one from AARP) or pull your Social Security Statement directly from the SSA. It’s important to note that you shouldn’t expect Social Security to make up a large portion of your retirement income.
What’s Your Number?
Once you know your estimated cost of living, have set a budget, and are aware of the funds from any SSA checks or pension you might receive, you’re better prepare to set a retirement savings goal for yourself. If you’re feeling daunted by the final number you’ve come up with, you’re not alone. Approximately 50% of all Americans have nothing saved yet for their retirement.
The good news is it’s never too late. I’d love to help you put a plan together to set a savings goal, build a retirement budget, and start working toward your best retirement. Set up an obligation-free consultation today to get started.
Remember that good financial planning is, by definition, good retirement planning.
Tony Velasquez is the Founder and Managing Director of Wisely Advised an Illinois Registered Investment Advisor. Wisely Advised provides comprehensive financial planning and investment advisory services to both individual and business clients. You can learn more about Tony and his firm here.
Any time you invest in the stock market, you’re taking on a risk. However, it’s important to understand that there are two different types of risk that come with allocating your assets:
Risk Tolerance v. Risk Capacity
Your portfolio is defined by two things: how much risk you can feasibly take on in order to meet your goals, and how much risk you can actually stomach. Your risk capacity is defined as the amount of risk your portfolio can handle. In many cases, your financial goals may be served with an aggressive investment strategy. This is especially true if you have many years to build a portfolio before you retire. You have more time to recover should the market drop, and your aggressive investment strategy has the potential to have a large payoff (Appreciation).
However, just because you can take on the risk doesn’t necessarily mean it’s the best strategy for you as an individual investor. That’s because investing isn’t just about crunching the numbers. It’s about building a strategy that helps you to achieve your goals without worrying yourself to death with every up and down the market faces. Knowing your risk tolerance can help you to understand just how much risk in your portfolio you can emotionally cope with. A better way of looking at this might be: risk tolerance is knowing how much risk you can take before you make a snap decision - like selling all of your stock and changing strategy when the market crashes and you start to lose money.
Everyone has a different risk tolerance and risk capacity. Knowing yours can help you make smart investment decisions that help you reach your short and long term goals, all while feeling confident in your investment decisions (and not losing your mind every time the markets drop).
Breaking Risk Strategy into Three Categories
There are three “risk categories” that your portfolio might fall into.
Aggressive investors typically are less impacted by market drops. This is because they have a high emotional tolerance for market risk and because they have an investment strategy that supports these highs and lows. Usually, that’s because they have a longer timeline for their investments to grow. For example, if you’re in your 20s or early 30s and are watching your retirement investment accounts grow, taking a nosedive over the course of one year won’t be that big of a deal because you still have forty to fifty years to bounce back.
However, if you have a shorter period of time to wait until retirement, you won’t have as much time to put money into growing your portfolio and your investment/retirement funds won’t have as much time to grow. This puts you at a lower capacity for taking risk on. You might also find that you have less tolerance for risk in these situations, because you know you won’t have enough time to “bounce back” from a large loss.
Just Because You Can, Doesn’t Mean You Should
It’s important to understand not only your risk capacity, but your risk tolerance. In other words: know thyself. Just because you can take on high-risk investment options doesn’t necessarily mean you should. Many people aren’t really involved with their asset allocation with any regularity. The market roller coaster doesn’t impact them emotionally, and they have no intention of touching their investments or getting in the weeds with asset allocation as a result of a market drop.
If this isn’t you, and you know are likely to sell everything when things go south (even if they could bounce back in a day, a week, a month, or a year) - then a lower risk portfolio might be a better option to maintain your emotional health. Ultimately, you need to find a strategy that you can stick with in the long-term.
Talk to a Professional
There are many tools available to help you determine how much risk you can take on. However, knowing how much you want to take on given your approach to investmenting and money is another story entirely. This is why speaking with a financial planning professional can be helpful.
A financial planner can help you develop a plan that strikes a balance between risk capacity and tolerance, and they can help you to regularly adjust your portfolio as time goes on and your goals shift. At Wisely Advised, we help clients create portfolios that push them toward their retirement savings goals while accounting for how much risk they’re willing to shoulder emotionally. More importantly, we help to alleviate the pressure of adjusting their investment strategy by tracking their investments for them, and rebalancing as needed.
Do you want help building a portfolio with the right amount of risk built in? Set up a free consultation today! We’d love to be on your team when it comes to investing wisely.
Tony Velasquez is the Founder and Managing Director of Wisely Advised an Illinois Registered Investment Advisor. Wisely Advised provides comprehensive financial planning and investment advisory services to both individual and business clients. You can learn more about Tony and his firm at www.wiselyadvised.com.
Tony Velasquez runs Wisely Advised, LLC a full-service Registered Investment Advisory Firm offering comprehensive financial planning and investment advisory services to individuals, families, and businesses.
Whether it's traveling, being at the beach, or at his family's ranch in Texas, Tony loves enjoying time with his family and friends.