On Wednesday, I showed you how to calculate the amount of money you’ll need in retirement — based on a variety of variables, including your pre-retirement income, the percentage of that income that you can live on in retirement and the number of years you expect to be in retirement. I even suggested that you find three or four goals for this — low, middle and high amounts — so that you have some realistic flexibility.
Even better is monitoring this savings along the line. Knowing what you should have already stashed away at age 30 or 40 or 50 can help you stay on track. If you’re behind, you can ratchet up your savings. If you’re way ahead, you can plan to quit your career a little earlier (or just bask in the really soft cushion you’ve created). Keeping an eye on these benchmarks helps you create a better plan.
But these calculations will naturally include a variety of assumptions — from how much you’re putting away in savings to the interest rates or return on investments. There’s no good way to really predict these, but retirement ratios have gotten pretty good reviews from some financial experts.
Charles Farrell (not the silent film star) of Northstar Investment Advisors created a set of multipliers, outlined in his book, Your Money Ratios, that make it really simple to estimate these benchmarks. (In this case, multipliers are merely numbers that you multiply by. In essence they’re parts of proportions.) Like my suggestion to have several goals, Farrell developed bronze, silver and gold standards. (Bronze is 70% of income, retiring at 70 years old; silver is 70% of income, retiring at 65 years old; and gold is 80% of income, retiring at 65 years old.) His website and book detail these standards and benchmarks in really handy tables.
Basically, Farrell offers multipliers for each standard and each age. Pull the multiplier from the table, multiply it by your salary and — viola! — you have easily calculated a good estimate for how much you should have already saved by that age and for that standard.
Let’s look a simple example: retiring at age 70, with 70% of your income. And let’s say you earn $50,000 a year. Here are four multipliers from Farrell’s tables: 30 years old at 0.45, 40 years old at 1.6, 50 years old at 3.5, 60 years old at 6.5 and 70 at 10.
30 years old: $50,000 • 0.45 = $22,500
40 years old: $50,000 • 1.6 = $80,000
50 years old: $50,000 • 3.5 = $175,000
60 years old: $50,000 • 6.5 = $325,000
70 years old: $50,000 •10 = $500,000
It’s not at all clear how Farrell came to these multipliers. (And I’m certain, like KFC’s secret recipe, he’s going to keep much of that to himself.) But, mathematically speaking, there’s something interesting to notice here. Your benchmarks are 10 years apart, but the difference between each goal is not a constant number. In other words, the difference between each consecutive year is not the same number.
Why is that? Well, if you think of the graph of compound interest, you’ll come to the answer quickly. Because compound interest is a curve, it increases quickly. This is a great thing when you’re dealing with savings. (It’s not so good with credit.) And if you look at the difference between each benchmark, you’ll see that over time, you’re retirement investments and savings are increasing by more and more.
And this should make perfect sense, if you look at the multipliers. These are not increasing in a constant way, either.
1.6 – 0.45 = 1.15
3.5 – 1.6 = 1.9
6.5 – 3.5 = 3
10 – 6.5 = 3.5
Each difference is slightly larger as you go up in age. If you were to graph the age and multiplier (or even product) on a coordinate plane (x-y axis), you’d have a curve.
The bottom line is this — as you age, you want your nest egg to increase exponentially, rather than linearly. In other words, you want your total to increase quickly, so that you can reach your retirement goals before you’re too old to take advantage of them.
What do you think of this process? How would having these benchmarks help you monitor your retirement savings more closely? Do you think it would be helpful to use these multipliers in your planning? Share your responses in the comments section.