Capstone Question for You:

How big a pile of money do you need to safely generate income from it to live off of? Of course that depends on many factors.

1) How much cash inflows do you have now/month? Inflate that number by 3%/yearly to estimate the impact of inflation on your cash needs. FV = (current monthly cash inflows) i = 3%, N=the number of years until you pull the trigger on living off your pile. Example of $8,000 of current monthly cash flow, 3% inflation factor, 20 years until the trigger is pulled. That means the $96,000 you live off today will need to be $173,386/year in 20 years. Use the Rule of 72 to complete a sanity check on your calculation.

2) Once you know how much much money you will need, just multiply it by 20 or 25 times to arrive at the pile of money needed to generate the income you need to live off. You can subtract the value of any social security or pension income you have from the required amount you will need to live off of. The 20 or 25 number come from the safe withdraw rate of 5% or 4% which should allow you to pull the amount out each year, yet still have your portfolio outgrowing the rate of inflation. Compounding is your friend when you are investing.

3) Once you estimate the pile of money needed, calculate the amount you need to save each month to achieve that pile. Then, do the same calculation assuming you started 10 years ago and also if you delayed doing this for 10 more years. Those two numbers should motivate you to action today.

Monthly PMT to Savings = (Future Value needed) (Monthly interest rate) (#of months in 20 years). In our example above without factoring in any pension or social security income the monthly rate to save would be:

Current: If you started from scratch and had no savings to start with the monthly number to reach the total saving goal of $3,467.72 would be $5,847. If you started ten years earlier, the monthly savings amount would only be $2,361/month.

The point of this exercise is to impress upon you the need to save for your long-term security now. Don't wait. Also, you need to understand the consequences of actions undertaken by your elected officials that stimulate inflation. It matters.

If you don't like your calculated results, you can work longer, increase your monthly savings, lower your monthly expenses or assume a higher rate of return than the 8% number I used for the example.

Thoughts?