It seems like such a daunting task. The mountain climb to the summit of retirement is quite the hike with many obstacles that can send you tumbling down the trail. Knowing you might need to save $1 million, $5 million or maybe even more than that when you factor in inflation can make retirement saving seem impossible.
Yet if we take the time to break down saving for retirement into manageable monthly chunks, we might just be surprised at what we find. One of the most important facets of retirement savings is consistency. I would rather you save $500 per month every single month than $6,000 once per year if you remember to do it. You are much more likely to see success by sticking to a set automatic plan for investing.
We just need to know what that number is.
How to Calculate How Much to Save Each Month for Retirement
Breaking down retirement into manageable pieces makes the task seem a lot easier. Here are the three things you need to know before you can calculate how much money you need to save each month toward your retirement.
1. What is my nest egg goal?
Of course you do need a goal in mind. Figuring out your retirement nest egg number is a completely different topic, but an important one to calculate. To come up with this number you need to estimate how much you will spend in retirement as well as what you think inflation will average up until your death.
If you only calculate inflation until you retire you may run into some cash flow issues once you start withdrawing your funds. It is better to aim too high and end up just fine in retirement than to aim too low and be running out of money while you are still alive.
2. What is my expected rate of return?
Next you need to know what you expect your investments to return over your life time. Since it is impossible to see into the future to determine what stocks and bonds will return, many people rely on historical returns. Over the last 50 years stocks have returned about 9.73% and bonds around 5.11%.
Once you know what you think your individual portfolio segments will return you should know what mix of investments you plan to keep. In other words 9.73% returns on stocks sounds great but is meaningless if you only keep 10% of your portfolio in stocks.
Your expected rate of return is important because it will be used to determine how much money you need to be compounding over the years to reach your nest egg goal. Just like you would rather aim too high with your nest egg number it is much better to aim too low on your expected rate of return number. Aiming low just means you will end up setting aside more money each month for retirement and end up with a larger nest egg than you expected.
On the other hand if your expected rate of return turns out to be too high – say 18% per year – then you won’t put back enough money each month and the end result will be a woefully inadequate retirement fund.
3. How long will I save for retirement?
The last piece is how long you expect to be saving for retirement. Will you work until you are 60? 65? Longer?
The period of time between now and when you stop saving for retirement and begin enjoying retirement will impact the calculations considerably. The longer you have time on your side slowly compounding your portfolio the larger your nest egg will be.
A 30-year old individual setting aside $5,500 per year into a Roth IRA (plus $1,000 catch up contribution once they reach age 50) and earning a consistent 7% return will have $840,412 if they retire at age 65. The same person will only have $570,685 at retirement if they hang it up five years earlier.
The Retirement Seesaw
Think of your retirement nest egg goal as the result of a seesaw.
On one side of the seesaw is your expected rate of return. The other side holds how long you will save for retirement.
There are many combinations of the two variables that will get you to your goal:
- You can have high annual returns and only need low contributions.
- You can have high contributions to your retirement funds and need a low rate of return to achieve the same result.
- You could have average contributions and average returns and still get the same result.
We’ll also assume you are saving for the same period of time in our comparisons. You need to figure that out first before balancing the seesaw.
How Much Money to Save Each Month for Retirement
Once you know your retirement goal amount, your expected rate of return, and how long you will retire then calculating how much you need to save is relatively easy. (You can use an online calculator or an Excel spreadsheet with a Goal Seek function.) You just work out a formula that builds in the compounding of a certain amount each year.
In my spreadsheet using some basic assumptions like linear portfolio growth, it turns out that with a 7% rate of return, our 30-year old investor that wants to retire at age 65 won’t make it to $1 million with just $5,500 contributions plus $1,000 in catch up contributions at age 50.
Instead, he’ll need to find a way to set aside $6,578.93 each year and then $7,578.93 once he hits age 50. If he does these things he will retire with $1 million.
Once you do your own calculation to figure out how much you need to save per year, just divide by 12 and you’ll have how much you need to save per month.
Have you figured out how much money you’ll need to save per month to retire? Leave a comment!