What track are you on?

Having established needs and wants in the previous post was a great first step. This article takes that line of thinking further where we work backwards and calculate “the big number”. This is your target retirement savings. This is how much you’re going to need to have to live comfortably when you decide to stop working. Many people write this number down, stick it on the fridge, commit it to memory or somehow make this their burning target. We talked last chapter about the brain-hacking benefits of committing to targets and this is a prime example.

The process in this chapter involves some basic financial calculations which are not overly difficult, but do require a little bit of work. Let’s get to work.

The first step is to get a rough idea on how much you spend in an average month. Amazingly, some people actually know this because they track/monitor on a spreadsheet. There are also useful bank accounts that help categorise your spending for you as well. If you don’t, then don’t worry as we will explore your spending habits further on in the Saving section of the book. For this calculation I’ll make it easy.

Calculating monthly surplus and projected retirement income

1-????????????????? Think about what you have coming into your current account on a monthly basis. That is, the net pay for you, potentially your partner and/or any other income.

2-????????????????? As the month ends think about roughly what is left over, if anything. If you’re not sure just think, does your current account generally move up or down over the year? If up, then you’ve got a surplus, if down then you’ve got a shortage.

3-????????????????? If you have ￡5 k per month coming in and typically have around ￡500 left, then spending is ￡4,500. If you have ￡5 k per month coming in and there is nothing left and in fact you continue to use around ￡1 k other savings each month, then your spending probably is ￡6 k per month.

4-????????????????? Take the total figure of spending and remove costs that won’t be there in say 20 years – that could be mortgage payments, school fees, car loan, life insurance etc. Also add back in any money that you are already contributing to savings or pensions. As an example, this could reduce spending ￡6 k per month down to say ￡4 k per month.

5-????????????????? Multiply this figure by 12. This is your annual projected spending for when you retire.

On paper this looks to be a very simplistic measure, however don’t let this fool you. It is precisely because it is simple it is so magical. For most people when you ask them what they want their retirement to look like, they will actually say is they want a life very similar to what they live today, just without the work. We are all creatures of habit. As we age we get used to a certain way of living with certain costs and we generally have in our minds an ideal plan to continue that standard of living into our retirement – hence using the same cost assumptions generally works as a rule of thumb. Think about that for a second. Is that correct for you?

The key to keeping this simple is not getting technical. Yes, inflation is currently a big issue, but far from a mathematical perspective we are just using the level of today’s money across all the calculations so we offset any need for using inflation by doing this.

Back to our example, a couple spending ￡4k per month therefore needs around ￡48k per year to live in the future. Great – now we then need to gross this up for tax purposes, which means that ￡48 k per year net spend, needs around ￡56 k per year in income.

Now, your turn. Do it for your own situation. How did you get on? Completing this exercise will give you a good assumption of your basic income need in retirement. How does that number feel? Is it more or less than you thought it would be? Just by simply doing this calculation puts you ahead of 90% of the population (based on my experience) who simply have no idea and just trust “everything will turn out ok.” I don’t know about you, but that is not something I am prepared to accept.

All well and good you say, but where is this income going to come from?

We’ve only just started with the maths – we need to continue.

Now we’re going to calculate the potential income you already will receive in retirement, and take it off the total income required. This leftover income is what we need to provide for. Make sense?

Calculating income

1 – State pension. As the rules are today at the time of writing, as long as someone has worked and made National Insurance (NI) contributions for 35 years over their lifetime, they will get the full state pension. Even if you haven’t made the full 35 years, and worked say 32 years, then it is pro-rated so you get 32/35ths of the full state pension. Mothers who take time off for children shouldn’t worry either because as long as they receive child benefit they are receiving credit for NI contributions so they are not disadvantaged. The state pension also has the advantage of the triple-lock which means it will go up by the lower of 2.5%, Average Weekly Earnings growth, or Consumer Price Inflation (CPI).

Married or have a long-term partner? Even better. As long as you plan to stay together you both will receive the state pension.

At this point the full state pension is around ￡9,300 per year, but this will continue to increase over time.

Back to our example, for a couple who need ￡56 k per year, this can contribute ￡18,600 towards that target, meaning there is around ￡37,400 left.

2 – Final salary or defined benefit pensions.

If you’re lucky enough to have one of these pensions, then they will give you a projection on what you are likely to receive at retirement date. Minus that figure off your target.

3 – Rental and other non-work-related income

Same as above for the other pensions. On the assumption this will continue into retirement, minus that off your target as well.

4 – Calculating savings target.

After you’ve set your initial projected income and now minused off the guaranteed income coming in, you should have a balance left over.

Using our example, let’s say this is ￡30 k per year. To calculate our savings target we simply multiply this figure by 25. So for the example this gives us a retirement savings target of ￡750 k.

Why multiply by 25? This is using a well-known retirement calculation called “the 4% rule”. The 4% rule suggests that if a retiree withdraws 4% off their retirement savings out each year then they are highly unlikely to run out of money. And 4% of ￡750 k is, you guessed it, ￡30 k per year.

There are many issues with the 4% rule, such as age of retirement, a big assumption on investment returns and the fact that spending slows down in your later years. When we sit with our clients, we go into far more detail with each of them around their own individual situation, however for this simplistic calculation it will suffice.

There you have it. When you think now, “How much will I need to save to retire to live the live I want to live?” This is the number.

This is the big figure you want to put on the wall as your retirement target. As I mentioned at the top of the chapter it may look like a big number, but now we have something concrete to aim for. A specific financial target for you.

You can do it.

Now we just need to work out how. With more maths. Starting today.

Let’s work out where you are today and then we can work out what the future path looks like.

Step 1 – Add up all your savings, investments, pensions, crypto, whatever you have.

(Brief note on mortgages: I’ll make the assumption here that if you have a mortgage it’s on a repayment term. By having mortgage as a repayment mortgage, I’m assuming this debt just takes care of itself over the life of the mortgage. This clearly impacts monthly spending as it increases your expenditure, but normally it is well worth it as it takes away the worry about paying it off eventually. Bit by bit, you will get there with a repayment mortgage.)

Look at the total value that you have saved today and compare that to the final figure. I’m sure it looks like you’ve got a long way to go. Don’t worry, it’s the same for most people.

However, you have an advantage. You are about to learn a secret that is so fundamental to the world of finance and the broader world in general Albert Einstein called it “the eighth wonder of the world”. Compounding.

Compounding is growth on growth. If something compounds at 7% for ten years in a row – it doubles. If you let it compound at 7% for 20 years – you make four times your original money. And what do you need to do? Simply not touch it! Leave it alone and let the market forces do the heavy lifting. We will discuss the benefits of compounding and time in the market further in the Investment section of the book.

Step 2 – On my website (www.adamwalkom.com) we have built an easy-to-use compound calculator. Plug in your numbers, choose an interest rate (start using 7% to see how you get on) and length of years to your planned retirement. I will go into much more detail on what figure to use in later parts of the book. For the sake of the exercise – and reality – you should choose somewhere between 2% and 9% for this figure. The lower the number, the more conservative you are being on the growth prospects, the greater likelihood you will achieve that number.

Take a look at the final projected number after you input the growth rate. If your current savings level achieves the final retirement figure without any more contributions – fantastic. You are there. You have built up enough assets to have a sustainable retirement based on the expenses we’ve estimated – congratulations. Now your work is just don’t mess it up!

However if you are like most people, there is more work to do. Most people will continue to need to put money away into savings, investments and pensions for the rest of their working life. There is nothing wrong with that. Don’t worry about the precision of this target because it is only a rough estimate.

Being precise about the amount you need to put away per month at the moment is pointless – and frankly can be depressing. Incomes change, events happen, inheritances arrive and other non-planned events impact everybody’s lives over a 20+ period. There is no point getting hung up on exact amounts so early on. The Savings section will look in detail at what you can put away and also give you a plan on how to maximise that figure.

There we have it. We have a target and we have a projected growth path for you at this point without any more additions to your savings. The gap between those figures may look large now, but the entire principle of the rest of this newsletter is reducing that gap in a planned, controlled way that makes it feel managed and even easy!

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