1.) Start with how much money you would need to live today. There are 2 ways to figure this out: You could calculate your base expenses and spending budget or you could take a percentage of your current annual income. (For this example lets assume I calculate that I make $60,000 in salary annually. Rule of Thumb says you would use 80% of this number. So my current living income for this calculation would be $48,000/year).
2.) Then determine at what age you would like to retire. How many years from now? (EX: Lets assume I would like to retire 20 Years from today.)
3.) We need to determine an assumed interest rate. Most industry insiders will use an interest rate of between 3-4%. (EX: To be more conservative in my calculations I will assume a higher inflation rate and select to use 4%.)
4.) Using a Financial Calculator adjust your income from Step # 1 to create an inflation adjusted income at your retirement age. (EX: Initial Deposit or Present Value/PV is $48,000; End Date is today's date 20 years from now or N= 20; Rate of Return or i =4; remember to compound annually. That equals an inflation adjusted income of approximately $105,000 at my planned retirement in 20 years.)
5.) Now determine what other sources of income you might have at retirement. For example Social Security or a company pension. (You can use the calculators at ssa.gov to help determine what your Social Security payment might be) then subtract that amount from the amount that you calculated in Step #4. ( Assume that I will have $30,000 annually in Social Security benefits, then my income gap is $105,000 - $30,000 or $75,000)
6.) Take your future income number from Step #5 and divide it by .05 which will represent a 5% withdrawal rate on your investments at retirement ( or divide by .04 to be very conservative) that result is the total amount of money you will need to retire, your number! (EX: $75,00 divided by .05 = $1,500,000 which is what I'll need to retire in 20 years from now)
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