September 30, 2002
If you socked away an additional $100 a month starting today, what will that buy you in retirement? Would you be able to join a ritzier country club? Will it be enough to cover groceries in your golden years? Would it pay for the mortgage on a vacation home?
We can't know exactly what today's savings will purchase decades hence, but from a few assumptions and calculations, we can get a rough estimate. Let's start with the assumptions:
- A rate of return: Stocks have historically returned an average of 10% to 11% per year, and bonds have returned 5% to 6%. Will they perform similarly in the decades to come? Who knows, but when it comes to financial planning, it's best to use conservative estimates.
- Years invested: How far away is your retirement?
- A rate of inflation: It's handy to know that investing $100 a month for 20 years and earning 8% will result in $60,000. Unfortunately, though, 60 grand in two decades will not buy what it does today (just as $60,000 in 1981 is worth $29,000 in 2001 dollars). Inflation runs, historically, between 3% and 4%.
- A withdrawal rate: Once you retire, how much can you take from your IRAs and be reasonably sure you won't outlast your money? Most studies conclude that a safe withdrawal rate ranges from 4% to 6% of a retiree's portfolio. Withdrawal rates above 5% increase the probability that a retiree will go broke.
Now, let's run the numbers.
Open this calculator.
Fill in the blanks. Enter zero in "Amount You Have Invested," since we're looking at additional savings. Also, enter zeroes in the tax blanks, since we'll assume you're contributing to a tax-friendly IRA.
Click the "Results!" tab, and then multiply the result by 0.04 for a withdrawal rate of 4%; 0.05 for 5%; and 0.06 for 6%.
Divide that amount by 12 and -- voilà! -- you get an estimate of monthly retirement income attributable to increased savings now.
Assuming an 8% annual return, 3% inflation, and 5% withdrawal rate, someone who is 20 years from retirement might reap an extra $168 (inflation-adjusted) in monthly retirement income from saving an additional $100 a month now. If you have 30 years until retirement, an invested Franklin now could provide an extra $338 (again, in today's dollars) in retirement.
So what are you waiting for? Up your savings today, and your retired self will thank you for the food, golf, and/or beachfront property.