How Much Money Do You Need to Retire? – Understanding the Concept of Wealth Equivalents

One of the most frequently asked questions for a financial advisor is “How much money do I need to be able to retire?” Well, the answer is both simple and complex. To get a real understanding of this question, you need to understand the concept of “wealth equivalents”.
The first thing to determine is how much money is needed annually to pay for your lifestyle. In other words, how much does it cost to live in the manner you wish to live? Let’s say, for example, that you spend $100,000 per year today to live comfortably. How much do you need in assets to provide this $100,000 in income? At a generous 5% rate of return per year, you would need a lump sum of at least $2,000,000.
And that doesn’t even take into consideration the effects of inflation. How much will inflation be over the next 20 years? Who knows? But don’t delude yourself into believing that it will be the artificially low amount of about 3% per year we experienced from 1990-2009. No, it will be more like 1970-1990—5% or more. With all of the government and banking manipulation of the markets, I don’t see how it can be any other way.
So, let’s say that we have 15 years until we wish to retire. At a 5% rate of inflation, we will need twice the income at that time to buy the same stuff we buy today. At $200,000 a year, that means that we will need AT LEAST $4,000,000 in 2025 to be able to replace that $100,000 that you would spend today to live. Now based on what you’ve got invested today, is that possible?
Don’t freak out. Instead of needing $4,000,000 in cash, you will need $4,000,000 in wealth equivalents. A wealth equivalent is the value of investments that, if those investments yield 5% per year, would provide the needed income to pay for your lifestyle. That’s $200,000 in income that will have to be created through work or investment income or a combination of both.
Retirement planning is about time management -- when you have the choice of earning money or using it to give you time. The better you plan, the more time you have. Now, if you earn $100,000 per year today, then your job has a wealth equivalent value to you of $2,000,000. That’s why most professionals will want to stay involved in their practices rather than selling outright – no one will pay that amount of money for the practice. The key is to figure out a way to generate as much income as possible from the practice with as little time commitment and risk as possible when you want to draw back, or retire, from the practice. A good financial plan will assist you in that objective.
Well, if you want to have some time in the future to pay your bills and you don’t want to go to work every day, then you will have to have some money set aside to create that income. One way I know how to do that is to save and invest it—taking at least 10-20% of your income off the top every paycheck. The other way is to be an excellent business administrator who can generate a six-figure income working one day or so a week. Both can be accomplished if planned.