Client L, Part 2: Roughing It Out

I’m meeting weekly with a friend, "L," to guide him through the retirement investment planning process. (All my posts about my meetings with L are tagged "Client L".) At our first meeting we drew up a roadmap to guide our planning.

His homework for the first week was to start to co-locate funds at Fidelity and to play around with the retirement calculators on the Bogleheads Wiki. L made some progress on these assignments but didn’t complete them (that’s OK, I’m not in any hurry). Between our first and second meeting he obtained the paperwork to move funds to Fidelity. Before completing them he wanted to review with me the tax implications of moving funds from a former employer’s 401(k) to a rollover IRA. I explained at our second meeting that such a move is not a taxable event so he has nothing to worry about.

At our second meeting we also talked through how to rough out how much one should save for retirement. This is not a replacement for careful investment planning (see my investment planning series for that), but it is a useful place to start. Here’s what I explained:

In general, though not universally, one will need in retirement something like 50% to 70% of one’s current income. For simplicity, let’s take the number 60%. Thus, R = 0.6C where R is retirement income and C is current income (all in constant dollars). The amount of money one can safely withdraw from one’s retirement nest egg annually is, relatively conservatively, between 2% and 4% of the initial principal. Let’s take the number 3% as the safe withdrawal rate. Thus, R = 0.03P where P is one’s retirement nest egg on the day of retirement.

Using these two expressions for R (retirement income) we can solve for P (nest egg) in terms of C (current income): P = 20C. That is, a rough approximation of what one needs to save for retirement is 20 times one’s current income. If your current income is $100,000 then you need $2 million saved for retirement (in current dollars). Don’t panic! This is a rough estimate. Don’t rejoice! This is a rough estimate. It is possible for it to be off by a factor of two. One must do more careful budgeting and planning to obtain a more precise estimate.

L and I also played around with the Ballpark Estimate calculator. We were pleased to discover that he seems to be on track for retirement after all. He just needs to keep it up and to organize his finances so he can manage and track progress.

L’s homework for our next meeting is to complete the movement of funds to Fidelity and to draw up a current household budget, as described in Household Budgeting the Easy Way. That should enable us to get a much better sense of his ability to save and will serve as the basis to determine his needed retirement income. If he has more time I also suggested he open a Roth IRA at Fidelity for himself and his wife. Also, he might begin to find information about Fidelity’s funds and those available through his current employer’s 401(k), particularly their lifecycle and index funds. We’ll be needing to know his options after another meeting or two.

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