If you’ve been planning to retire in the next few years, odds are that you’ve spent a lot of time reviewing your investments, including the account balance, the specific investments you own, the asset allocation you have, and even reading about proper distribution strategies.
While all of that is important, you’re actually missing the most important thing to know before you retire: Your Retirement Expenses!
Simply put, nothing else matters until you figure out how much you want to spend on a monthly basis in retirement. If you’re spending too much relative to your portfolio, it simply isn’t going to work out. On the other hand, if you don’t have as much saved up as you had wished, but your living expenses are modest, then you actually might be in better shape than you think.
Let me tell you a quick story: When I first got started as a financial advisor, I went into a meeting with some clients with my boss. These were new clients, so as is typical in the first meeting we were trying to understand what their financial and retirement goals were. So my boss asks them, how much would you like to spend on a monthly basis in retirement?
Without hesitation, the husband says $25K/mo. And no, he wasn’t smiling when he said this. He wants to spend $25K per month. Well we just make a note of it and discuss it a little but after the meeting my boss and I get to creating their financial plan.
These folks were in their early 50s, and when we start running the numbers and analyzing things it’s pretty clear that there’s no way they’ll be able to generate $25K per month in retirement.
So in our next meeting, my boss, who was great with client relationships and communication, really starts to drill down into what they actually need to spend to live a comfortable retirement. What will their housing expenses be, what do they need to keep the lights on and food on table, what do they need to spend on fun/hobby activities, and once she was done with that, do you want to know the total number we arrived at?
$5,000! Yes, they only needed $5K per month, not anywhere close to $25,000K/mo. Where did the husband get the $25,000 number from? I’m honestly not sure. I can’t remember if we asked him about that or not.
But let’s do some simple math on what a difference the math makes. The average social security check in 2022 is around $1,657/mo, per person. So for this gentleman and his wife, let’s assume their total social security benefit is $3,314.
That means if they want to spend $5,000/mo, then they’d need $1,686 from their investment accounts. $1,686 times 12 is $20,232 that they’ll need, over the course of the year. If you follow the 4% rule, which I’m not sure you should, but it’s a decent rule of thumb so we’ll start with it. So to find out how much you need in your accounts to generate $20,232 over the year, you simply take that total amount and divide it by 4%. 20,323 / .04 = $505,800.
In other words, if you have $500,000 saved up in investments, at a 4% distribution rate, you can roughly get around $20K per year from your investments, which helps these folks get to the $5,000/mo mark that they want in retirement.
However, let’s go back to the initial number that the husband wanted, $25,000/mo. Using the same numbers: $25K/mo over the course of the year is $300,000. Then you take $300,000 / .04 = $7,500,000, which represents how much you’d need in investments to spend $300,000/year. That’s 7.5 MILLION DOLLARS. I don’t know about you but it would take me a long time to save up $7.5 million dollars. I also don’t have any idea on what I’d spend all that money on.
My point here is that there’s a dramatic different in terms of what you need to have in your investment accounts, solely dependent on how much you want to spend. If you want to spend a lot of money in retirement, you better have the investment accounts to back up that number. On the other hand, if your means are more modest, you simply won’t have to have as much saved up.
Further, knowing what that monthly number that you and your spouse need makes a tremendous difference in how you plan for your retirement, and how quickly you can retire. The question I think about a lot personally, and with my clients, is: What’s more valuable: An extra $1,000 to spend in retirement, or the time freedom to do what you want with your life, how you want, completely on your terms?
I’m a modest guy, so the answer for me is simple: Let me choose how to live my life, and I’ll make sure the dollars and cents works out. But I don’t want to play by anyone else’s rules longer than I need to just for a couple extra bucks.
Your answer to that might be different than mine, which is completely fine. Regardless: You do need to drill down on what that monthly expense number is for you and your spouse, and then start seeing how the numbers stack up. Because once the numbers are clear, then your plan of action becomes clear. But if you have fuzzy numbers or you haven’t spent any time on these numbers, then no one is going to be able to tell you if/how/when you can retire.
I hope this is helpful and that you all have a great week!