How Much You Need to Provide a Retirement Income
How much you need to accumulate to provide a retirement income is based on your specific needs and objectives. At some point in time, anyone thinking about retirement will need to address the issue of providing sufficient cash flow from their investments or other assets to replace their employment income. In other words, when your income generating ability ceases, you will need to rely on your own assets (possibly in addition to Social Security) to provide the cash flow or retirement income you will need to maintain your standard of living.
Do you know when you will be financially independent with enough money to stop working? Despite the simplicity of this question, there really is no simple answer, reliable retirement calculator or rule of thumb. How much you need to finance your retirement depends on how well you want to live and the expected length of your retirement life. Since everyone is unique with their own specific goals, how much you need to accumulate to provide a retirement income is based on your specific needs and objectives. How you go about calculating this number is complex and requires a certain amount of skill and expertise. There are several reasons why.
First, in retirement planning, the return on your investments depends to a large extent on the allocation of your investments. For example, with one portfolio, you might project that your investments will grow at an average rate of 9%. In this case, a one-time investment of $100,000 could grow to approximately $560,000 in twenty years, based on a 9% average annual return. Based on the asset allocation of another portfolio, you might project that your investments will grow at an average rate of 7%. At 7%, that same $100,000 could be worth approximately $387,000, a difference of almost $175,000. The difference in the rate of return between one investment portfolio and another is due to the specific asset allocation strategy. An assessment of your risk tolerance will help you identify the portfolio with the specific asset allocation strategy most appropriate for you.
Second, some people make bad investment decisions based purely on emotion. For example, when stock prices are declining, many people make emotional decisions based on fear and begin to liquidate their investments. According to Dalbar, Inc., an independent research firm, investors often underperform the very funds they are invested in. They attribute the difference between investor returns and mutual fund returns to 1) an investor’s unsuccessful attempt to try and time their investments and redemptions and 2) the fact that investor holding periods are generally much shorter than the holding periods of mutual fund companies. In their 2008 Quantitative Analysis of Investor Behavior, the average equity investor would have underperformed the S&P 500® by over 7%, earning a meager 4.48% annualized return over a twenty-year period ending December 31, 2007.
By way of example, a one-time investment of $100,000 based on the average equity investor’s average annual return of 4.48% over a twenty year period would have grown to approximately $240,250. A one-time investment of $100,000 based on an average annual return of 11% over a period of twenty years would have grown to approximately $806,200. This is a difference of over $565,000.
You should always construct your portfolio based on a rational investment process. There is no one particular investment portfolio that is appropriate for all individual investors. The optimal portfolio for you will depend on the amount and timing of your cash flow needs, tax considerations and market conditions. You’ll want to make sure your portfolio is well diversified based on your time horizon and risk profile adjusting your holdings as asset values change in order to maintain the desired allocation between stocks, bonds and cash.
Another important factor in the calculation is an estimate of your expected annual personal expenses during retirement. This sounds easy, but accurately projecting how much you may spend in retirement can be difficult. Do you anticipate that your expenses will increase or decrease in retirement?
By developing a detailed retirement plan, including a
year-by-year cash flow and expense projection over the years, you can
implement an investment plan that will enable you to retire when you
wish with the retirement income you need to maintain your standard of
living.
Return from Retirement Income to Retirement
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