Part II: Setting 10-year Plan Goals
When you think about how prepared you are for your retirement, do you see your glass as half empty or half full? No doubt we can all be better prepared. Have you ever heard anyone complain that they were too prepared or had saved too much (meaning their glass was too full)? Probably not!
When setting the goals for your 10-year plan, it’s important to start with a set of goals that get you closer to a “half full” state of mind. You can always adjust the goals over time as you get more clear on how you want to live in retirement and whether that is realistic.
In Part I of this three-part series, I recommended keeping your goals simple: focus on Retirement Savings, Cash and Real Estate (or Housing if you never plan to own a home). Here in Part II we’ll discuss how you can come up with the goal amounts for each of these three categories. Part III will cover how to chart your progress.
So, How Much Is Enough?
This is a really personal question and will likely change over time. You can’t possibly forecast all the events that will happen over the next ten years. Your income could change, you might move, have children, get married or divorced. There are many things that can affect your ability to achieve your goals so don’t get too worried about identifying the perfect number because it will likely change. Think of this as a starting point.
The easiest way to come up with a number is to base your future living standard on what it costs you to live today. For now, don’t complicate things by trying to factor in inflation rate, medical care costs or long-term care insurance premiums.
Sure, some costs will increase, but other costs go down or be eliminated. You may not need two cars or even one depending on where you end up living. Today you might be paying for child care or school; you should leave those costs in because some cost you aren’t considering will take its place.
Get Really Clear About Today’s Costs
You must have a very honest and realistic idea of what your life actually costs to get a usable number. If you don’t know that now, here are some links to prior posts that will help you nail it down.
- Use the Monthly Expense Tracking worksheet in this post to get a good idea of what you spend on recurring monthly expenses. It’s a good idea to do this monthly so you can refine your understanding of exactly where your money goes and adjust your goals accordingly.
- Use the Future Capital Expense worksheet in this post to identify costs that don’t occur monthly (like insurance premiums, school tuition, etc.).
Once you have that information, you can come up with an annual figure for your costs. To create an example we can all follow together, let’s say you need $2,500/month, which is $30,000/year (you really need roughly $36,000 to cover federal and state income taxes based on 2012 rates for a California resident).
Calculate How Much in Savings You Need to Generate That Income
Okay, using our example above, we said you needed $36,000 to cover annual living expenses and taxes. The question now is how much do you need to save to generate that income?
If you are very conservative, you’d probably put your money in a money market or a bank CD and may only earn 1.5%, which means you’d have to save a very large amount to generate $36,000 in interest.
If you have a high risk tolerance and a lot of time ahead of you, you might invest in higher-risk mutual funds or stocks and hope for a 12% average annual return. If your gamble paid off, you’d be able to save significantly less and achieve the desired goal.
I’ll use a middle of the road option. For the sake of our example, I’ll assume we’re going to invest in Vanguard’s STAR fund. This is a balanced fund that has been around since 1985. Based on historical performance we might estimate an average annual return of 7.25%. (Remember, there’s no guarantee that any fund will perform based on its past performance. And, I’m using this fund simply as an example, you would need to do your own research to find a fund or mix of investments that is appropriate for you.)
So, based on a 7.25% projected annual rate of return, you would need roughly $500,000 in savings to generate enough interest income to cover your taxes and living expenses. MoneyChimp.com has some great calculators that can help you come up with your numbers. Here’s a screen shot of their compounding interest calculator showing how I arrived at $500,000.
- Begin by entering a guess at what you think your total savings figure will need to be in the Current Principal field. This is a starting point to test whether that amount will be able to generate enough interest to cover your income needs.
- Leave the Annual Addition field figure at zero.
- Enter 1 in the Years to Grow field.
- Enter 7.25 or whatever interest rate you think is reasonable for your situation in the Interest Rate field. Leave the rest of the fields at the default setting and then click Calculate.
- Subtract the Current Principal amount from the Future Value amount to see if you end up with the needed income.
You’ll probably end up having to play with the figure in the Current Principal and/or the Iinterest Rate fields. Be sure not to be too optimistic about how much you can earn, especially if your time horizon is shorter.
Now you have the information you need to start setting your three goals.
Your Retirement Savings Goal
We start with your retirement savings because you want to save as much you can in this category and then cover the remainder of your overall goal in your cash category. We covered some of the benefits to using retirement vehicles in Part I of this series.
Find out how much can you save in your retirement vehicles.
- Check the IRS for current IRA contribution limits, and
- Check with your employer for 401k contribution limits and company match.
Based on what you find out, calculate how much you are allowed to contribute each year over the next 10 years. For our example, let’s say you would be allowed to contribute a total of $250,000 ($5,500/yr in an IRA and $19,500/yr in a 401k or similar program).
If you love the company you work for and believe you can stay long enough to become fully vested in the company match, then count that in your calculation. Leave it out if you think you may leave before being vested.
Your Cash Goal
The difference between the total amount you need earning interest and what you’ll be able to put in your retirement accounts over time will become your cash goal.
In our example, you need $500,000 earning 7.25% to cover your living expenses and you set a goal of $250,000 for retirement savings. Given that, you need to save another $250,000 in cash.
Your Real Estate/Housing Goal
Okay, so now that you know how much in savings you need, it’s time to think about housing. Where do you think you might want to live in retirement? What are the housing costs there? What would it cost to buy a home there that you would be comfortable living in? If you prefer to rent, what are the rents like? Granted, things will change and prices will not be the same in 10 years or whenever you plan to retire; however, you have to start somewhere so just use today’s prices.
For our example, let’s say you would be happy in a home that cost $250,000 so that will be your Real Estate goal. For renters, this goal would net you a rental for around $1,500/month if you had the money in a fund earning 7.25% annually.
Congratulations, you just did something scary. You took a look into the future and figured out how much money you may need to live comfortably in retirement. For many of you it will feel unattainable, but trust me, it builds up faster than you think.
In our example, we’ve set an initial overall goal of $750,000:
- $250,000 in retirement funds
- $250,000 in cash
- $250,000 in real estate
Remember, this is just a starting point. The idea is to get on the road to saving for your future. These numbers can and will change as you become more in tune with your true expenses, what you want for your future, your investing savvy and the economy.
If the numbers are too scary at this point and make you feel frozen, cut the numbers down…right now it’s more important to set some goals and stay focused.
What Can You Add to the Conversation?
If you have other methods for goal setting that you like, please share them in the comments below. If you’re struggling with setting goals, you aren’t alone. Please share your frustrations or successes below.
Don’t miss Part III in this series. In it I’ll give you a free one-page worksheet and explain how to track your progress over the 10 years. It is incredibly motivating and rewarding to maintain this chart…give it a try and you’ll see what I mean!