Over the holidays, I ran across a nice article by Philip Brewer over at Wisebread. In it, he talked about how much you’ll need for retirement in the context of safe withdrawal rates, using the 4% rule as an example.
In other words, if you assume that you can safely withdraw 4%/year from your retirement portfolio, then you’ll need $1M to provide $40k/year in living expenses. While the exact “safe withdrawal rate” has been debated ad nauseum, that’s somewhat beside the point for our purposes, so let’s not get hung up on the specific number.
Instead, I want to highlight a very important point that Philip made:
“The calculation also works in reverse.”
That’s right. This calculation also works in reverse. So if have anticipate having living expenses in retirement of, say, $50k/year, you’ll a retirement nest egg of $1.25M ($50k is 4% of $1.25M). That’s a whole lotta scratch, and it might be somewhat daunting to be staring down the barrel of that number.
Let’s say you’ve saved and saved and saved, but you’re still short of the goal with $1.1M — a full $150k short of where you need to be. The good news is that you can fill that gap in your portfolio by earning $6k/year through whatever means you have at your disposal.
Whereas $150k might be a large, imposing number, $6k/year doesn’t sound nearly as bad, does it?
Looked at another way, if you’re willing to cut $6k/year off your living expenses, and make do with $44k instead of $50k, you can stop saving and start enjoying your retirement that much earlier — i.e., once your nest egg hits $1.1M vs. $1.25M.
Of course, this is all highly sensitive to your assumptions. Maybe you need more or less, or maybe you’re comfortable with a higher (be careful!) or lower withdrawal rate. Those details will vary from person to person. But the general principles outlined above hold true for all of us.
As Philip puts it, capital substitutes for labor — and vice versa. That is, with a big nest egg on your side, you can stop working and let your investment provide for you. Or if your nest egg isn’t quite big enough, you can supplement it with a bit of sweat.