So my last post was about embracing your financial self as a legit aspect of your life. Because it’s not enough to just make money; that’s the bare minimum below which you become outright homeless. If you ever want to be more than just this side of homelessness, you have to embrace your financiality and figure out what to do with those dollars. I used to jokingly think that all my hard-earned money was basically for pizza and beer, like in college. And then I realized that’s exactly it: it’s college thinking at best, and now I have to get serious.
So why not skip straight to what is on my mind? How much money do you need to retire (a.k.a a sustainable level of independent wealth), and how do you get from here to there? Mr. Money Mustache has published a well-known and clever formula: your annual spending times 25. It makes total sense to me, with the assumption that you plan to be retired for 25 years. MMM goes on to say that this number would tip you in the direction of being able to retire for much longer than 25 years due to compounding interest of investments, but this is a good baseline idea of what you would need to save, at a minimum. Say your monthly total costs are $2000, for an annual cost of $24,000. Your baseline required retirement savings amount would be ($24,000 * 25) = $600,000.
Now say you are like I was a few years ago, and you figure “well, my 401k will take care of everything right??” So I found a Bloomberg 401k Calculator for this. Say a 25 year old guy gets his first real job making $50k and starts a 401k at zero. This calculator indicates that if he contributes 4% of this $50k with a 100% company match up to 4%, the 401k will grow to $692k in 35 years when he is 60. Pretty great right? Well, I am not asking about the breeziest way to arrive at your retirement number by 60, I am asking what is the best and fastest way to arrive at your retirement number and get on with retirement if you so wish. If you wanted to retire by 50 just with 401k contributions, your savings would fall way short at just over $309k. The account would continue to earn interest after you retire, but it would obviously grow less, and you’d need more savings.
I hear a lot of people talk about maxing out 401k contributions ($17,500 total for 2013), but I have mixed feelings about this. For reference, the 25 year old above would save a cool $2.6 million in 25 years putting the maximum $1458/month into her 401k, or would reach the baseline $600k goal at that rate in just 11 years at age 36. But the limitation of not being able to take penalty-free distributions until you are 59 1/2 makes me nervous. If you actually wanted to retire at 50, you wouldn’t even be able to get to your 401k money for 10 more years. Using the original formula, you’d still need ($24,000 * 10) = $240k in more accessible funds to spend from age 50 to 60. So why would I want to spend all of my working years depositing so much into something I will not have access to for so long? It seems to me that the only true value of the 401k is the win-win company match. 100% return on investment. Beyond that I would rather invest elsewhere.
There’s always the Roth IRA, but that also has the 59 1/2 age limitation for taking distributions. But I would still be willing to max that out at max $5500 in contributions/year. Then what?! After spending 4% of my annual income in 401k and $5500 in Roth IRA, I should be set with about $350k in retirement accounts by the time I’m 50 (but cannot touch until 60). I will need to save at least $240k more over the next 25 years to cinch up the 10 year gap. This could be done by dumping $800/month into a savings account for the next 25 years with a pessimistic 0% return. But again, I’m not looking to snore my way to retirement. I want to blast there.
Of course, there is the consideration that the earlier you want to retire, the more you will have to save up front, and the longer you would have to wait to access “retirement” funds. So there is a linear aspect to it as well as investment and lifestyle considerations.
This is all discussion for now. I’m still paying loans. But this kind of thinking brings a plan into focus. I will be thinking about this $240k as I go along. I hope it has given you something to think about as well.