One million, two million or much, much more?
There are a lot of different answers out there.
For early retirees the simple answer is to have about 25-30 times your annual expenses saved in investments.* So if you spend $60 000 a year you need to have $1.5 - $1.8 million in investments.
Before you attempt to correct me lets see where this number comes from.
For your nest egg to last forever you need it to increase at the same rate of inflation (this has averaged 5.24% since 1951 but the target is 2-3%) and then a little bit extra to allow you to withdraw some of your money to live on. The percentage of money you can withdraw is termed the Safe Withdrawal Rate (SWR). The SWR allows you to increase the amount you withdraw each year to account for inflation.
The measurement and analysis of the SWR comes from a number of different studies. Most of these are based on US stock and bond data. The most commonly cited study is the Trinity study which found that you could withdraw 4 percent of your principal for 30 years with a 95% chance of success, where success means your money didn't run out completely.
The Financial Services Institute of Australasia has recently published a report on SWR in Australia.** They compare data from 5 countries with different annualised stock performance using real returns. Australia has had the highest returns of all countries so they suggest using historical data from Australia to anticipate future returns may be a little optimistic. The study also extended the time frame to look at 40 year periods (beyond 40 years there would be little change to the overall success rate). They also used a variety of different portfolio asset allocations (100% stocks, 75% stocks/20% bonds/5 % bills, 95% bonds/5% bills etc). It is worth noting that generally the higher the proportion of stocks in the portfolio the higher the SWR. This study has not allowed for fees or taxation which may alter the results.
Essentially whilst the 4% rule would have worked over shorter time frames there was much more risk over longer time frames. A 3% SWR approached 100% chance of success except in the 2 lowest performing countries studied, which performed so poorly that not even a withdrawal rate of 2% met with a great deal of success.
So why have I said to save 25-30 times your annual expenses?
If you saved 30 times your annual expenses you would have a 3.33% SWR which in most cases would give you a fairly reliable chance of success (possibly leaving you with a nice sum at the end).
If you wanted to retire and live completely from your investments then a 3% SWR would be quite safe (there is no such thing as a sure thing).
Using a 4% SWR would also work if you are adaptable. You may do a bit of paid part time work. You may be able to decrease your spending in economic down turns. Maybe you will receive an inheritance. Maybe you will downsize your house. But to blindly withdraw 4% from you portfolio and increase this every year for inflation exposes you to some risk of ruin.
Using the rule of having 25 times your annual spending, if you spend $80 000 a year you would need about $2 million to retire. If you spend $40 000 a year you would need $1 million. What is easier? Saving an extra $1 million or adjusting your expenses and spending less?
To give you a rough idea of what you could expect to spend, acccording to ASFA Retirement Standard a retired couple would require $33 000 a year for a modest retirement and around $58 000 a year for a comfortable retirement (we will look at these figures and the definition of modest and comfortable later).
So that is how much you need for retirement. Work out what you currently spend and multiply it by 25-30.
Then look at what you currently spend again and see how much that would be reduced if you stopped work (no uniform costs, no professional fees, no commuting, no work lunches, etc) and then multiply that by 25.
Now you have a rough goal.
But we won't stop there. We will look at every aspect of our annual expenditure and see how much each area can be adjusted for maximum efficiency and fun!
* This figure is for early retirees. Those retiring at an older age don't need to have their money last forever so can afford to spend the principal.
**The full pdf format can be downloaded here. An interesting read if you like numbers, charts and graphs.