05. How much do I have to save for retirement?
You may still have a long way to go, but time passes quickly. Besides, we already know that one of the basic rules of investing is to start early. So, if you want to reach 67 – yes, my friend, as of 2027, if you haven’t contributed for at least 38 years and 6 months, the retirement age in Spain will be 67 – with financial independence, you have to invest. If you haven’t started yet, here are some ideas.
Why invest? You might think that, if you save enough, you can have a cushion that will allow you to face unforeseen events and have a peaceful retirement. And that’s true. But keeping your money in the bank, or stashed away at home, is an inefficient way to save. Let’s say that, to make the most of your savings, there is only one sure way: choose investments with a moderate risk and contribute periodically over many years.
Thus, investing for retirement will help us to increase our capital, protect us from inflation, generate passive income and, in general, to have more financial flexibility. In other words, with the right mix between profitability and risk, we will be able to have more money, maintain – or even improve – our purchasing power and secure additional sources of income. In short, we will have more financial options to adapt to the changing needs of retirement.
How much to save for retirement
Of course, the more we save and invest, the more likely we are to have a comfortable retirement. But we also have to live in the present and deal with expenses and unforeseen events during our working lives. So the million-dollar question is: what is the minimum I need to save for retirement – without giving up on enjoying life today.
We’re sorry to tell you that there is no one-size-fits-all answer. Determining the amount of money to save for retirement depends on a number of factors, such as your retirement goals, desired lifestyle, your life expectancy, inflation, and the performance of your investments, among others. There is no single amount that is right for everyone, as everyone’s needs are different.
However, there are some key factors that will help you get a reliable answer. The first thing you should know is precisely the legal retirement age and your desired retirement age. In addition, it is advisable to calculate your estimated expenses – housing, food, medical care, travel… -, your reasonable life expectancy, expected income – pensions or Social Security – and the rate of return on your investments.
It is also essential to assess our level of risk, regularly review our savings plan and consider seeking professional financial advice to get a more accurate and personalized estimate. With all that information, we can then figure out our safe withdrawal rate, i.e., how much money we will be able to withdraw per month in retirement from the savings we have managed to accumulate.
The safe withdrawal rate
Again, there are no simple answers to this question. Thanks to William Bengen, a suitably retired financial advisor, we have a rough estimate. The safe withdrawal rate rule provides a general guide. In most cases, you will be able to withdraw about 4% of your initial savings in the first year of retirement, and adjust that amount in subsequent years for inflation.
So first you will need to calculate how large your portfolio is likely to be by the age at which you are expected to retire, based on your estimated return and recurring contributions. Nowadays, this calculation is provided by several banking and investment institutions. Secondly, you will have to decide whether 4% per annum of that amount is a sufficient sum to cover your likely needs along with the rest of your income.
This rule is based on research conducted by Bengen and published in October 1994. Bengen made his calculations by taking as reference several portfolios composed of stocks and bonds and their performance over 50 years. The starting assumption is that the withdrawal rate should allow funds to be withdrawn for at least 30 years without running out. In 1998, the so-called Trinity study confirmed the results obtained by Bengen.
The study examined withdrawal periods of between 15 and 30 years. The main conclusion was that “if history is any guide to the future, then a withdrawal rate of 3% or 4% is extremely unlikely to deplete any portfolio of bonds and stocks over the periods considered”. Thus, 4% is considered to be a safe withdrawal rate as a general rule, although Bengen insisted that planning is critical, since, when we are talking about investing, nothing is guaranteed….