Investment Strategy

How much do you need to retire?

Today we’ll ask a difficult question. Or at least it’s a question with an uncomfortable answer. How much money will you need to have to survive retirement? Of course there’s no “correct” amount. But we can get some pretty good clues on the ballpark figures.

Most people work for around four decades, give or take a few years. These days they often start their careers saddled with student debts. Then they have to take on huge mortgage debt to buy a home (or at least to rent most of it from the bank).

Over time the homes get bigger as families grow, and so do the mortgages. Many take out other loans as well, such as to buy a car.

Keeping on top of the debts is a challenge in itself. Paying them off as fast as possible should be everyone’s first priority with any money they can spare.

Keeping on top of the debts is a challenge in itself. Paying them off as fast as possible should be everyone’s first priority with any money they can spare. Cutting out the interest cost is a certain way to be better off in the long run.

Of course having money to spare can seem like a challenge in itself, especially for families with kids. But the reality is that most middle class people can save at least some money each month, if they really want to.

First of all they have to take control of their spending, and not worry about showing off to the neighbours. Whether or not they go by the name of “Jones”.

Let’s say that each month you manage to save 5% of your net income after tax. In other words you spend 95% of what comes in. If you manage to increase your saving to 10% of net income then you’ll still be spending 90%.

In other words, doubling the savings rate has only decreased spending by 5.3% (5% divided by 95%). Make the same move from saving 10% to 15% and your savings rate goes up by half, whereas spending has decreased just 5.6% (5% divided by 90%).

This is a key insight for anyone who wants to provide for their future.

Relatively small cuts to current spending can lead to huge increases in saving. Understanding this is a crucial first step in planning for your future financial security and ultimately for a comfortable retirement.

Of course you then have to invest those funds for the best long term outcome. It’s not good enough to simply stuff it into bank deposits. The best thing to do with the money will depend on what’s currently going on in the markets and the economy.

By and large, most of the time, the bulk of your money should be invested in stocks. Owning small pieces of many businesses, most of which will grow over time, is the best route to investment profit. Just make sure they’re bought at a reasonable price (the cheaper the better!) and held for the long term.

Don’t concern yourself too much with short term price swings. If markets crash then you should buy more stocks once the dust has settled. That’s when the best bargains are on offer – when prices are low.

What you mustn’t do is panic and sell at the bottom. Every year you should reinvest the dividend income for maximum profit compounding (profits on the profits).

Right now cheap stocks are in fairly short supply, especially in the developed markets, and particularly in the USA (see here for more on the expensive US market and the risks of investing there). So, for the time being at least, I recommend a mixture of cash/deposits (or T-bills, which are just ultra-short maturity government bonds), gold, and emerging market stocks where there is value.

Eventually US and European stocks will trade at more sensible levels and it will be time to buy them too. Practically all developed market bonds offer extremely poor value these days and are best avoided.

Real estate bought as an investment can also work out well, provided you research the local market and can generate a healthy net rental yield. That’s after all taxes and costs, such as mortgage interest, commissions paid to letting agents and maintenance.

If you start saving and investing as early as possible, are patient, and stick with it, over time you’ll build up substantial investments.

If you start saving and investing as early as possible, are patient, and stick with it, over time you’ll build up substantial investments. These may or may not be inside a pension fund of some kind.

I recommend you try to have pension funds – which offer tax breaks – and other non-pension investments as well – which are more flexible in terms of what you can invest in and when you can take money out.

Now we get to the difficult question of how much is enough. How big should your investment funds be?

What will you need when the time finally comes to disconnect your nose from the grindstone and enjoy your hard earned retirement? Of course this depends on expected annual living costs and how long you are retired for.

But let me give an example, which hopefully gives you some clues. I wanted to know roughly how much money someone would need to survive 20 years of retirement without running out of funds. So this assumes someone is retired from age 65 to 85. Of course they could live longer, but I’ll come back to that.

There are loads of unknowns, so I’ve had to make assumptions that seem reasonable. The first is that investment income will be taxed at 20% on average, being a blend of dividend income and capital gains. I’ve also assumed living costs will go up by 3% a year on average, which is consistent with consumer price inflation in the USA over the past three decades.

Finally I’ve set required net income – the money that can be spent in year – at $50,000 in year one. That amount then increases with inflation over time, as prices of goods and services go up.

If you think you’ll need more or less than this then just scale the results up or down. So if you reckon you can get by on $25,000 a year then divide the fund size in two. If you think you’ll want $100,000 a year then double it.

Based on those assumptions I’ve then worked out how big the retirement pot needs to be, subject to a range of average annual investment returns during the retirement period. At the same time as you’re drawing out money you also want the remaining funds to keep growing. The lower the on going returns the more money is needed in the starting fund, and vice versa.

So if all the money makes only 1% a year before tax – say from cash and short term government bonds – the fund would have to be $1.3 million to last 20 years, with $50,000 to live on in year one.

If the retiree achieved 10% a year gross return – which would require pretty much all of it to be in stocks, and most of them deep value stocks bought cheaply – the required fund size drops by more than half, to $630,000.

Above 10% a year is unrealistic for most people, so I haven’t gone above that level. Here’s a summary of the different outcomes:


Remember, this is just an illustration. And it assumes no funds are left at age 85. To be safe you’d want to add some more in case you live for longer. Say 20% more.

Assuming a conservative gross annual return of 5% – on average and before taxes and inflation (but after fees) – this points to something around $900,000 being enough for someone that needs $50,000 to live on in retirement, in today’s money.

Add 20% safety margin and we’re looking at somewhere around $1.1 million being the target. The bigger it is, the more secure you’ll be, and vice versa.

Part of that money could come from selling your own house and moving to a smaller one. That’s assuming it’s too big for your retirement needs, once the kids have left home and so on.

But if that capital is released early in retirement, or before it, it will still need to be invested in stocks for best results. Otherwise it could be sitting around in low return cash deposits for 10 to 20 years.

Of course there’s no right answer to how much you’ll need for a comfortable retirement. This is just an illustration, and my assumptions could turn out to be off the mark. But I hope it shows that most people have a mountain to climb, especially in a low return world.

Unfortunately there’s no easy way around this. You can’t rely on your government to bail you out when the time comes, unless you want to run the risk of living in poverty.

Most governments are already struggling to balance their books. And the pressure on state budgets can only increase over time as populations age – meaning more people claiming pensions and needing healthcare.

If you don’t already have substantial assets – net of all debts – you need to start saving and investing as much as you can, whatever your age. It’s never too late to get started, or to accelerate your rate of saving.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.