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 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.