Call it f*$k you money or call it a retirement fund, everyone’s probably thought about solving the issue of needing money. At some point in your life you’ve probably wondered – how much is enough? How much money will genuinely see me through the rest of my life?
The bad news is, there’s no definite answer. The good news is, there is always an approximate answer, and that’s good enough.
What you need to consider
You don’t need to be a financial professional to understand how much money you need to live on. The math behind it is pretty simple. It’s the guesswork that’s difficult. Not only do you need to know how much money you need every year, you need to estimate it many decades into the future. If you’re middle aged right now, you need to know how much money you’ll be spending every month when you’re 80 years old.
That means you’ll have to account for inflation over the next few decades, as well as the return you can earn on your money. It’s easy finding out how much a rental property, dividend stock, or bank account pays in interest every year, but you need to do your research to figure out how much these assets will yield when you’re older.
To simplify things, start with a rough calculation and adjust it upwards to get the right figure. If you think you need a $1 million, assume you’ll need $1.5 million to be safe.
Finding out how much you need
To find out what you need, follow these steps:
Step 1. Figure out how much you spend to live every year.
Step 2. Find out what the risk-free rate of return is in your country. In the US, this would be the yield on a 10-year Treasury bond.
Step 3. Divide the annual living expenses by the risk free rate. That’s the amount of money you need today to live on forever.
Step 4. If you want to figure out how much you’ll need many years in the future, simply double the figure from the last step for every 35 years or so.
These four steps will let you know how much money you need to live on. Note that this method assumes you will earn the lowest possible return on your money – the risk-free rate – which eliminates the need for you to make wise investment decisions. In practice, your wealth will be invested in a diversified portfolio of dividend stocks, rental properties, and ETFs that probably yield more than the risk-free rate.
Let’s take the average American for this example. The median household income in the US is currently roughly $56,000. The yield on a 10-year government bond is 2.33%. That means you’ll need a little over $2,403,433. That’s $2.5 million to live on forever at the nation’s median income. That’s a lot of money, no doubt, but if you have it you’ll never need to work or worry about not having money ever again.
If you’ve figured out how much money you need to live on, you need a rock-solid investment portfolio to help you get there.
A few well-picked dividend stocks should help you compound your wealth at a reasonable pace so that you can retire on your savings comfortably. Take the time to learn about dividend investing, valuations, and picking the right investments. A few good moves today will have you set for life.