August 1, 2009

How much would you need in retirement?

Is an early retirement possible for you and/or your family? How much can one expect to save if he/she regularly invests and saves their money up until their retirement? This is a serious topic because there are several sources of information telling us that if we save regularly for X amount of years then by the time we retire, we will be millionaires. But how much value will a million dollars hold by then?

I’ll provide a clear example of this:
Let’s say that William Brown makes $40,000 today and decides that he wants to have $1.5 million by the time he retires in 40 years from today – which would make him 68. He expects to receive an average pay raise of 6%. According to Bloomberg Retirement Calculator – If he made regular contributions and saved at least 20% of his salary annually he would accumulate a sum of $1,732,188 – which actually exceeds his goal (excluding Social Security) by the time he is ready to retire.

Brown believes that he is on track to a successful retirement if he averages an 8% return on his investments. Unfortunately, he did not consider the actual value his $1.7 million will be 40 years from today. Using TVM (time value of money), we are able to calculate how much $1.7 million is worth today to get an idea of what it would be like for Brown to retire in the future.

Using the formula of TVM:

FV/(1+r)^T = 1,732,188/ 1.08^40

This will give us an understanding of what Brown’s retirement will be worth in the future – or rather what will $1.7 million be worth 40 years from now. After solving for the equation we find that Willam Brown’s retirement will be worth roughly $79,734 for retirement. Assuming we don’t have a mortgage, credit cards, or any other bills that prevent our savings for retiremet – who can survive off of just $79k? Imagine the lifestyle adjustment....

According to Bloomberg, Brown needs to aim higher – and save more money in order to retire comfortably as the Time Value of Money erodes his retirement value.

How many of us can successfully retire?