This is rapidly appearing to become a blog about your Number … of course, that’s not the case: it’s a blog about money, specifically about how to make $7 million in 7 years, but you can pretty quickly see that having a real financial goal in mind is a powerful focusing tool.
It’s also a ‘comparator’ – a tool to use whenever you are presented with two financial alternatives … for example, Scott who is deciding how many clinics to open: 1, 2, or 3+ [Hint: only one of these is the right answer, and it’s not the obvious one!] … it was ONLY by having a clear understanding of his Number / Date that he came to this conclusion.
Without that understanding, Scott could have made a terrible (OK, far better than terrible … more, non-optimum) decision that would have had the opposite effect to that intended: it would have committed him to working for 10 to 20 more years.
So, now that I have provided the hint, let’s look at today’s conundrum, posed by Money Magazine in March 2008: how much money should you have saved by now?
Well, given the current market the chances are that what you have saved has halved, but what you should have saved hasn’t … bummer 🙂
But, here’s what Money Magazine advises; to see how much you should have saved by now:
If you are age 45 multiply your current salary by 4.1
If you are age 50 multiply your current salary by 6.1
If you are age 55 multiply your current salary by 8.5
If you are age 60 multiply your current salary by 11.4
So, if I said my current salary was $250k (well, that’s what I most recently paid myself before I retired), then I should have saved $1.525 million by now …
Can you see the obvious problem?
Well, it assumes that I am going to want to keep working for another 15+ years!
Why? Simple: $1.525m can only support a ‘safe’ 5% annual withdrawal rate of $76,250 (before tax) … so, unless I want to take a HUGE pay-cut, I’m going to have to keep working until I’ve saved at least $5 million … lucky that’s exactly what I did 😉
So, here’s how you should calculate how much you should have saved by now:
1. Calculate your Number,
2. Decide your Date,
3. Subtract your Current Net Worth from 1.
4. Subtract today’s date from the Date
5. Divide 4. into 3.
That’s how much you need to have saved each year between now and your Date, if you want to reach your Number.
Now, you can get fancy and use an online compounding calculator to do the year-upon-year calculations, but this is a good place to start.
@Adrian. I’ve done a simple spreadsheet that does the subtractions between dates and the Number and current net worth.
http://spreadsheets.google.com/pub?key=t9WqKJrj_uMNj1WPpnRpj0w&output=html
I summarise it here with Scott’s figures:
End date: 01/01/19
Today’s date: 16/07/09
Days: 3456
Years: 9.47
Number: 4,000,000
Current net worth: 223,452
Difference: 3,776,548
Diff / yrs: 398,854
Is that the result you would expect? Or should I alter the spreadsheet?
KC
@ KC – Thanks for the s/sheet! I’m having “permissions” problems gaining ‘edit’ rights, but to get to $4 mill in just under 10 years from an almost standing start (relative to $4 mill. that is!) sounds like a $400k-a-year savings exercise to me 🙂
The Money Magazine approach does not work for me either – for the reasons you give. And you can’t work backwards using their numbers (e.g. using their age 60 figure for what you should have if you want to retire in five years time at some earlier age) because they have assumed a given life expectancy and (I suspect) drawing on social security.
Your approach is more sensible, but it assumes a linear rate of progress. This may be reasonably close for short time periods but starts to look a bit uncertain for longer time periods because I’d assume most people doing it the hard way (i.e. saving from a salary) would:
1. having rising incomes as they gain experience etc – which should lead to rising dollar savings everything else being equal
2. have uneven savings rates because everything else is seldom equal (marriage, children, house, divorce, illness, tax increases, working for Lehman Brothers etc)
3. start to benefit from compound returns as they accumulate assets and they start reinvesting the returns on those assets
If you are running your own business it would be even more volatile and unpredictable.
Now if you can come up with a spreadsheet that takes into account all those variables….:-)
@ Trainee – when you come up with the spreadsheet, log it in here 😉
Now, the compromise would be to put in compounding numbers, which have the effect of ‘loading’ the annual (hence, cumulative … which is what Money Magazine’s figures are) savings rates in later years …
… but, doesn’t that just take the pressure off us to perform in the early years, when it matters most? That’s why I’m reasonably happy with the linear approach for anything up to, say, 10 years to your Date: the proverbial kicketh up thy owneth backside! 🙂
@Adrian
The spreadsheet would be a bit too challenging for me but I will have a go….after I hit my number and have some spare time
I suppose compounding could encourage some people to slack off in the early years but it would have the opposite effect for me because (i) I did push myself hard to maximise savings in the early years of my career and (ii) the early savings benefit from the effects of compound returns more than later savings
My savings is begining to pick up, one of the things I did was open an account that I automatically deposit into but it takes some specific work to withdraw. I also have an “ING” account, so I at least have a savings plan.
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