One million dollars used to mean you were incredibly wealthy. Even if you didn’t have a secret lair. One million dollars meant you could do practically anything! To give you an idea – $1 million in 1960 would be worth over $8 million in 2016.
Sadly, the days of the really-wealthy millionaire have passed. One million dollars is no longer considered wealthy, but at least you won’t be living in a cardboard box drinking a bottle of swill wondering where it all went wrong.
Nowadays, in some personal finance circles it’s said that $1m is enough to retire on. Is it really enough to retire on?
Those of us living the dream of financial independence know it’s not how much you have, but how much you spend that actually matters…
Looking At The Numbers
We know from the Trinity study that a portfolio of common stocks can support a withdrawal rate of 4% for a period of at least 25 years.
In the past, I’ve argued that the study is a little out of date given our current economic conditions. Instead, I prefer the 3% rule due to my longer retirement timelines (30+ years!) and the very slow economic growth we’ve seen in current decades.
Depending on the withdrawal rate you use, a $1 million dollar portfolio can provide between $30,000 and $40,000 of income per year.
Is that enough? Well, don’t go spend it all on the first Ferrari you see….
Everyone is going to have different spending levels (of course). The single guy living in a one room apartment eating ramen every day will have a very different spending profile from a family of 4 with ravenous young children.
Some people are going to be naturally frugal, and others will be natural spend-thrifts.
The Bureau of Labor Statistics defines the average annual expenditure of a family in the U.S. as $53,495. That’s clearly well above the $40k/yr earned from our hypothetical $1 million. Better hold off on the champagne for now.
If one million isn’t enough, how much do we need? How do we determine how much to save for a decent retirement? Some rules of thumb say you should save 25 times your annual income. Is it really that simple? Let’s dig a little deeper…
Determine Your Needs And Your Comfort Level
There’s a whole spectrum of different spending levels — from frugal, to moderate, to spendy, and beyond.
This is why determining a good retirement budget is tricky; one person’s spendy is going to to be another person’s frugal. It needs to be personalized.
My recommendation is to forget what everyone thinks you should be spending. Forget about how frugal they say you should be. Forget silly rules like “80% of your pre-retirement income”, or “25 times your annual budget”. Forget about people with extremely low levels of spending. It’s your life, and your retirement.
Instead, make your own definitions about what retirement looks like. Find a level of spending that works for you.
Will it be Comfortable? Frugal? Or Spendy?
Begin With A Budget
Start by looking at your current annual budget. If you don’t yet know what your annual budget is, you need to start tracking it. Without knowing a baseline-level for your spending, you really can’t proceed any further.
Once you’ve got your annual budget in hand, you’ll need to ask yourself a few questions:
- Is this budget comfortable in the long run?
- Can I afford to eat healthy? Or, can I eat what makes me happy?
- Am I satisfied with my current level of travel
- Am I satisfied with my current level of entertainment?
- Do I want to have different hobbies?
- Can I afford decent health care at this level?
- Do I have enough buffer in the budget for unexpected issues?
Nobody is going to be able to answer these questions for you. You need to do it. [Note: If you have a spouse or significant other, you should definitely be discussing these questions together]
Once you know how you feel about your current budget, you’ll know where to put yourself on the Retirement Budget Spectrum (RBS).
The Tako Family Budget
I find examples always help, so I’ll use the Tako family’s budget to illustrate…Our current annual budget is $48,000/yr.
We feel pretty happy with this budget, and we’ve been living this way for years. We are healthy, and well entertained. Our house is probably bigger than we need. We eat pretty much anything we want. We don’t drive fancy cars. For travel, we take short weekend trips, and usually one big family vacation (with flight) per year. Spending on entertainment is otherwise pretty minimal.
I call this level of spending Restrained. We’re not extremely frugal. Things are a little tight because a huge chunk of our budget goes to child-care. But that won’t last forever.
Once our kids get older, I expect some of it will pay for things like education expenses, kids clothes, and after-school clubs. The rest of it will probably be needed for healthcare. (Those costs just keep rising!)
So, could we go lower on the Spectrum? If we were willing to make some tradeoffs…
I could keep Tako Jr. #1 at home with me. We could travel less. We could ride bikes or take the bus. We could spend less on food (rice and beans anyone?) But I wouldn’t want to live that way for long.
That level of spending reaches down into Extreme Frugality. That’s an uncomfortable level of frugality for me. I don’t think I could maintain it for decades. The good news is, this means we have buffer room in our current budget.
If the economy went to hell, we could tighten our belts and spend less.
On the opposite end of the spectrum, we could also spend a lot more. We could travel more frequently. We could go out to dinner more. We might even buy clothes that were not from the thrift store.
I imagine a life with enough extra income to waste some of it on comfort, but not spend with abandon. I call it the Comfort Budget.
Doesn’t it sound like a nice retirement budget? It certainly does to me! It’s the Goldilocks of retirement budgets — Not too little, and not too much.
How much extra would we need per year to attain the Comfort Budget? I estimate an additional $10,000 a year would be enough to give us that extra bump into the easy life.
A total of $58,000/yr.
Interestingly enough, this is slightly above the average annual spending covered in the BLS report, which gives me a certain level of confidence in this number.
A life with extra creature comforts should have a slightly above average budget. Mind you, that’s not Giant Jackass levels of spending.
Going From A Budget To A Portfolio
Once you understand your desires on the Retirement Budget Spectrum, you can then work backwards to find the ideal portfolio size.
Finding the ideal size is as simple as dividing the ideal annual budget by the withdrawal rate:
Ideal Portfolio Size = Expected Annual Budget / Expected Withdrawal Rate
In our case, the ideal portfolio size works out to be $1.93 million dollars. We expect to have an early retirement that exceeds 30 years so we continue to use the 3% rule for our calculations.
If you have a shorter retirement timespan (or are more confident in the world’s economic prospects), you could use the 4% rule.
It’s Not Even Close To 1 Million
Obviously our portfolio needs to be a lot larger than the aforementioned $1 million. But $1.93 million is a life we’re going to be comfortable with!
There’s wiggle room for living through bad times, and living it up during the good times. If we tried to live on less (like $1 million), it would leave very little room for error.
I don’t know about you, but nothing in my life ever goes smoothly! I always plan with a decent buffer. My FIRE budget is no exception!
Thankfully, our current portfolio is actually very close to our ideal….We now have about 2.1 million in assets, and roughly $1.8 million we could liquidate quickly if need be.
I think we’re ready!
What kind of budget will you plan for retirement? Will you enjoy spending, or will you enjoy a spartan life of frugality?