Made up numbers

In previous finance posts I've mentioned how Joanne & I are currently maxing out our 401k plans and Roth contributions. With employer match, that's a nice chunk of change. It occurred to me back in January that perhaps we were overdoing it--our savings was approximately 40% of our gross salary. Not that that is bad, as our flexibility to do so was possibly nearing an end, and we weren't going without to do so. Still, the argument that investment house calculators were on the extreme side to get investors to stash more money in accounts did make me wonder--was our savings rate a function of need or fear?

To check, I created a quick and dirty spreadsheet of my own, very simplistic, but capturing the major elements of a 60 year plan. I didn't keep that one in no small part because it wasn't postable, but then last week I realized/remembered about the existence of google docs, so another one was born. Just as simple, even if not fully explained.

So what does this capture?

First, there's some initial data/assumptions:

• Age - self explanatory. I didn't include a retirement age, rather letting the spreadsheet do (most of) the work to determine when the savings target was hit
  
• current savings - another easy one. how much we have now. I do fudge on this a bit, since i count all liquid assets, which would include the "emergency fund" and Owen's 529 (we went with West Virginia)
  
• planned contributions/savings - a little trickier, but I kept a rather high baseline, with a small increase in a couple of years (still less than inflation)
  
• expected return - I left this one open ended, in which i could input a random assortment of returns. I got bored with that, but it's still an option.
  
• expected inflation - somewhere between 3-3.5%
  
• withdrawal rate - standard practice is 4%. that is, you withdraw 4% of the portfolio in year 1 of retirement and increase that by 3-4% each year (inflation). growth is supposed to maintain portfolio size to mitigate the erosion of value from inflation, giving a high probability of the portfolio lasting 30 years. an alternate approach is to withdraw a fixed percentage of the portfolio, so retirement income may vary depending on return.
• current standard of living/desired standard of living in retirement in 2008 dollars. this would be the most important non-assumption input in this, as it dictates contributions. Pre-Owen, Joanne and I managed to spend $50-55K per year. Debt payments (ie mortgage) is about $13K. So we'll call that $40K/year would be necessary in retirement to match our current SOL. The general rule of thumb is that 80% of this would be necessary in retirement. However, this does not take into account taxes, or an increased SOL because of travel and other things to keep busy with no job. Income taxes are not included in the spending total, and since 401k/non-Roth IRAs are taxable income need to be included, that requires some adjustment to the standard 80%. So I left it at 100%--the mortgage payment budget line simply becomes a tax payment line.

The last three provide the size of the necessary nest egg: standard of living times expected inflation to the number of years to retirement power all divided by withdrawal rate (S*IpR)/W. Based on that, our target nest egg is $3.5 million. No problem!

Even leaving our contributions largely flat (only increasing when Owen prospectively is done with college) and getting an average return that is hopefully not too optimistic (7%, falling to 5% closer to retirement), we'll get there with some room to spare. However, this assumes the flexibility to maintain those contributions, a willingness to stick the the investment plan, no catastrophic decline in markets, particularly as retirement gets closer, etc.

The numbers don't really indicate we're saving too much like I'd hoped. They did the first time I did this exercise--I think I used some combination of a slightly lower inflation rate, a higher rate of return and/or increasing contributions. Either that, or I messed up a calculation. I remember finding we'd have a SOL more than twice as good as we currently do, which is a bit much.