Say, for example, that your initial retirement income each month will be $3,500. Your monthly expenses tally to $5,000. Here, your gap is $1,500 per month. This is the perpetual gap that you’ll need to fill each month.
Now that you have a sense of your real-time retirement numbers, it’s time to plan for how to fill the gap. Here’s where your retirement savings portfolio comes into play. I go into more detail on this in a book, You Can Retire Sooner Than You Think, but just remember: With investing, there are the two prongs of wealth building.
Total Return = Growth + Income.
With income, we garner cash flow in the form of stock dividends, bond interest, and distributions that come from other areas of the market like REITs and pipeline companies. Conservative estimates say we can expect between 2.5% and 4.5% yield each year over time. Again, this is just the income piece of the equation.
Let’s turn to growth now. Estimating overall growth is far less predictable than income, as it relies heavily on how well the stock market and economy fare in any given year. Again, let’s be conservative and aim for 3% to 4% growth each year.
When we combine the numbers from growth and income, we get a range of between 5.5% and 8.5%.
With this in mind, we can work backwards to find how much money we need to have invested to create a total return that will “fill the gap” in our monthly retirement income. Let’s use a 4.0% withdrawal rate to keep these numbers conservative. If you need $1,500 to fill your retirement gap, that’s equal to $18,000 per year. Divide that number 0.04 (4.0%) and you get $450,000.
$1,500 x 12 = $18,000
$18,000/0.04 = $450,000