How much do you need to save? - ch 6 Bogleheads series at Catch a Gideon

November 7th, 2006 by digerati

This is Chapter 6 of the Bogleheads Series at Catch a Gideon. The series goes through the book The Bogleheads Guide to Investing and gives the highlights of each chapter along with my comments and additions.

Well, it depends. Most people don’t have a clue where to begin figuring this out. Generally, they don’t know how much they need to enjoy a comfortable retirement. I’d say too that most people couldn’t tell you how much they need to get through a year now, comfortably or not. All this causes them to worry that they are not on track to meeting their retirement goals. Of course I think that’s silly; you can’t possibly meet goals if you haven’t got them.

Here’s what impacts the amount needed for a good retirement (financially of course):

the amount you save.
your current age. The longer you have the more compound interest will help you.
The age you plan to retire (30 doesn’t count!)
How long you have to live off your retirement (again, being 30 doesn’t count).
Do you want to leave an estate to your children (or that Tibetan hooker the firm took pictures of you with…). Or do you just not want to run out of money before you .
The expected rate of return on your investments.
Whether you can expect an inheritance prior to retirement.
Other sources of income: social security (haha), reverse mortgage, and part time work.

The easy ones are current age. Hmm, thats it. Our current savings are easy enough too, but it is much harder to determine how much we should be saving, or to motivate ourselves to save consistently.

Retirement age depends mostly on when you have the money to retire. With people my age (their early 20s) it also means “what is retirement?” I don’t really plan to retire in the traditional sense, but I certainly don’t want a full time job. The problem is I’m trying to get out of that arrangement in 10 years or so. I can hardly call that retirement, but at the same time it complicates things further. I generally just pick an age, usually 60 or 65 to play with the numbers.

Years in retirement is hard too. How long do you plan on living? My friends say they are done at 30, sometimes 40. While I fully understand their stating this, it’s probably just not true. But will you live as long as your grandmother? Will science make you live much much longer? Who knows. I’d pick a number based on family history. For me I’d say 85 or 90.

Leaving an estate. Do you want to leave your children something? I can’t answer this personally sine I’m not near having children. I would like to think I’ll be left something though my parents did not have this idea when my grandparents started to die. I’d like to think I can be successful enough (and then teach my children to be successful enough) to not need an inheritance. It should be what’s left over, not what is expected. Still, you need to decide for yourself whether you want to leave something. Maybe you even want to use up your money early if you don’t like your kids. It’s your choice, but plan for what you decide, don’t just let something happen.

Estimating future returns. I think people probably over estimate their abilities when they are young and underestimate them later. Young people think there is some sort of crystal ball to determine the best investments. I broke mine playing dodge ball, and most people’s don’t look to be in the best of shape. Their are good average numbers based on index funds and the market and various segments of it over long periods. While past performance does not indicated anything in the future, the market has never deviated from this general trend for very long, certainly not 40 years. If you invest in a manner befitting a Boglehead you should be pretty close to these average returns. Generally they say stocks average a 10% return (7% real return).

To determine your return over time: take the estimated return on each type of investment and multiply by the percent of your portfolio. Sum the products and you’ll get your average return. Here’s the example from the book:

US Large cap stocks = (30% X 8 % return) = 2.4
US small caps (10 percent X 10 percent return = 1%
International expected return = 20 percent X 8 percent return = 1.6%
REITs = 10 percent X 8 percent return) = .8%
Intermediate term corp bonds = (30 percent X 5 percent return) = 1.5%

2.4+1+1.6+.8+1.5% = 7.3 percent total return on your portfolio.

Beware of RTM (reversion to the mean). This rule states that a market segment that has been doing well above average for a period of time will likely do well below average for another period of time. It gives everyone a turn at the top!