For most people still in work, this is the most important question when considering their retirement savings. I wish I could tell you that there was a magic number to aim for, like £100,000. Or even £200,000. For many who are struggling to make ends meet, these sort of figures may seem out of reach. For those lucky enough to have high disposable incomes, these sort of savings targets may seem too easy.
The truth is that ‘enough’ depends on a multitude of factors that differ from person to person. Let’s consider a few of the most important.
Defined Benefit pension
If you’re lucky enough to have employment that provides a defined benefit pension plan, then there’s very little uncertainty. Maybe you don’t need to save any retirement savings at all, provided your projected pension meets all of your retirement needs.
When to retire
Different people will have different attitudes to this. Some may love their work so much that they never want to retire. Of course wanting to work, and being able to find paid work, are two different things. A retirement plan that assumes you’ll never retire is no plan at all. Ill health, redundancy or loss of job satisfaction are all possible reasons why retirement might become desirable for even the most enthusiastic people. So everyone should assume a reasonable retirement date.
Some people may dream of retiring as early as possible. For them the decision to retire may hinge upon when they will have saved enough to support their desired lifestyle. They may have decided to save a fixed amount each month towards retirement. So their retirement date may be a moveable feast, which depends upon how the investments perform.
How much to put towards retirement savings
Rather than first deciding how much to save towards retirement, maybe you are assuming a fixed retirement date. You then need to work out how much you need to save each month, in order to retire on the date you want. This in turn leads to the central question of this article, namely how much accumulated retirement savings is enough. Assuming you can determine this, which is a big “if”, then you can then roughly estimate how many more years of work you need to put in.
Standard of living
Many people equate their standard of living to their salary. The problem with this is it leads us to overspend and under-save. Retirement planning maturity involves mentally breaking the direct connection between spending and salary. I explained this in a previous article.
Ignoring tax, let’s say person A earns £40,000 a year, but only spends £20,000 a year, and is therefore saving £20,000 a year. Person B also earns £40,000 a year, but spends £30,000 a year, and so saves only £10,000 a year. Not only does Person A save twice as fast as Person B, but also Person A needs to save less money than Person B to fund his £20,000 spending in retirement, whereas Person B needs to fund £30,000. So Person A will be able to retire much earlier than Person B.
There’s a whole website devoted to encouraging people to reduce spending in order to achieve an early retirement. Even if you don’t want to be that frugal, you need to understand the need to find the level of spending that is most compatible with your planned retirement date.
If only we could generate huge returns with no risk! A cruel fact of investment life is that the higher the expected return, the higher the risk. Generally speaking, risk translates into volatility, which means the extent to which market prices tend to fluctuate. Watching your retirement savings go up and down like a yoyo causes many of us to stress out. But going for the safest investments may not generate enough growth to fund our retirement.
Striking the right balance between risk and reward is hard. It’s made even harder because the ideal balance tends to vary with age. Highly volatile investments may suit young people, but may be far too risky for older retirees.
In some cases, some retirees with no dependants may be best served by eliminating all market risk and going for guaranteed annuities.
As if we haven’t already found enough things to worry about, we also don’t know how long our retirement savings will need to last! Maybe you have a fair idea of what your average life expectancy is.
As an example, let’s assume that it’s 25 years, based on your current age and gender. The fact that it’s the average means that there’s a 1 in 2 chance that you’ll live longer than 25 years. So planning for 25 years is risky. How about 30 years then? You’d have to consult tables of statistics to work out the odds of living longer than that. Let’s say it’s 25%. That’s still a bit risky. What about 30 years then? Or 40?
If you plan for an exceptionally long life, then maybe you’ll drastically cut down on your spending, but you’ll probably not live as long as that after all. Also, a longer than expected life only creates a financial problem if it coincides with poorer than expected investment returns.
Just like the uncertainty and risks of investment returns, life expectancy is full of uncertainty. You need to balance enjoying jam today with the possibility, but not certainty, of needing jam tomorrow.
So how should I plan?
There are so many factors to juggle. The task of planning may seem impossible. Here at EvolveMyRetirement® we’ve recognised how difficult it is. So we’ve created a retirement calculator that really helps. It works out optimised choices based on your specific financial circumstances.
Of the factors that we’ve mentioned, the only one that EvolveMyRetirement® can’t automate is your expected retirement date, as it depends on so many emotional and personal factors. You’ll need to make a sensible assumption here.
Everything else is automated. You’ll learn your optimised discretionary spending. Anything you don’t spend you can then put towards your retirement savings. Rather than target a magic retirement number, you’ll learn your high level spending and investment strategy. Of course, we strongly recommend validating this with an independent financial advisor before putting it into practice.