I’ve long argued that one’s quality of life should be a principal factor in deciding when to retire. At the same time, however, financial considerations can’t be ignored. With this in mind, here are three rules of thumb to help you decide whether you’ve reached the perfect age to retire.
1. Have you saved enough money?
The “multiply by-25″ rule is a popular tool that
retirement experts encourage people to use to estimate whether they’ve saved
enough money to stop working and, at least hopefully, begin a life of leisure.
Here’s how it works: Multiply your desired annual
income in retirement, less projected annual Social Security benefits, by 25. If
your savings are greater than that, then you’re in good shape. If not, then you
may not be financially ready to retire.
For example, let’s say that Bob and Mary Jane
estimate they’ll spend $40,000 a year in retirement. Using the rule of 25,
they’ll need savings of $1 million.
A slightly different iteration of this is the
“multiply by-300″ rule. This is the same thing, but it focuses on months
instead of years — that is, take your average monthly expenditures, minus your
monthly Social Security check, and multiply that by 300.
If your savings are greater than that, then you’re
all set. If not, then you might want to continue working for a few more years.
2. Will you have enough income?
This question is related to the first one, but it
attacks the issue from a slightly different angle. As such, it also has its own
rule of thumb: the 4% rule.
This rule holds that you can safely withdraw 4%
from your portfolio every year and still be confident it will last through
retirement. Thus, to determine if you’ll have enough income in retirement,
multiply your portfolio by 4% and then add in your projected annual Social
Security benefits — to learn one potential problem with this rule:
If the sum of these two numbers is enough to cover
your expenses, then you’re ready to retire. If not, then it may behove you to
put off retirement for a while longer, as doing so should allow your portfolio
to continue growing. It will also give your Social Security benefits time to
accrue delayed retirement credits.
3. Is your portfolio properly
allocated?
Finally, determining if you’re ready to retire
isn’t just about how much you’ve saved, it’s also about how your savings are
allocated into various asset classes — namely, stocks and bonds.
To be ready for retirement, you want to make sure
that your assets are invested in as safe of a way as possible. To do so, it’s
smart to steer your portfolio increasingly toward fixed-income investments like
bonds as you approach your desired retirement age.
Experts use the following rule to determine the
proper allocation: “The percentage of your portfolio invested in bonds should
equal your age.” Thus, if you’re 60 years old, then 60% of your portfolio
should be in bonds and 40% in stocks. If you’re 55, then the split is 55% to
45%, respectively.
While this may seem like it has less to do with the
timing of retirement than the former two rules, the reality is that it’s of
equal importance. As my colleague Morgan Housel has discussed in the past, one
of investors’ biggest mistakes is to underestimate the volatility in the stock
market. According to Morgan’s research, stocks fall by an average of 10% once
every 11 months.
Suffice it to say, a drop of this magnitude would
have a material impact on both of the preceding rules, as a 10% decline in your
stock holdings would equate to a much smaller income under the 4% rule and, as
a corollary, it would call for a delayed retirement date under the multiply
by-25 rule.
And the impact of this would be even more
exaggerated if the lions’ share of your assets were still in stocks as opposed
to bonds. Consequently, the culmination of your strategy to bring your
portfolio into accord with this final rule is a key step in determining the perfect
age at which you’re ready to pull the trigger and actually retire
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