Almost everyone knows that they need to be saving more money for retirement. Good advice about budgeting is everywhere. People always feel like they need to be saving more, and they don’t always know how much is enough. That means that the motivator for most people is guilt or fear. But having a clear goal and knowing you are on the right track would be more effective than always combating feelings of inadequacy and dread.

The first steps are obvious. You need to get an income if you don’t have one. Then you need to pay down high-interest debt if you have it. Next put aside enough emergency cash for several months of necessities. After that is the time to seriously consider retirement savings.

You have to decide how big of a nest egg you want to build. There’s a formula that can take the guesswork out of it. Someone once taught me the following definition for wealth:

You are wealthy when your investment income is enough to cover your expenses.

When your investments earn enough to pay for your lifestyle, you are free from needing employment income. This strategy will bring more peace of mind than a strategy that allows you to live off of your retirement account for a certain number of years. The prospect of outliving your retirement money is nerve-wracking. The safe alternative is to plan well enough that you could live off of your investments forever. This doesn’t mean that you have to be super-rich. There are only two numbers that really matter–how much you want to save, and how much you want to spend. So if you want to be wealthy, you can get there by either saving more, or by scaling back your retirement spending. (Paradoxically, the people who learn to live with the least are also the wealthiest).

To make a concrete goal, you need to come up with a number. First decide how much you are going to live off of. You can do that by adding up all your current expenses, for necessities like food, clothing, housing, transportation, and medicine. Alternatively, you can take your current income and subtract the amount that goes to taxes and debt and savings. Either way you should get a number close to how much you consume right now. Don’t include housing in the figure if you will have paid your mortgage before retirement. Then, you can adjust the number downwards if you know you will retire frugally, or upwards to retire extravagantly.

Suppose that you currently earn $36,000 annually, but you think you could live off of $12,000 after retirement. The first thing you should know is that you are going to need to put in the bank a little more than 20 times your estimated budget. So since $12,000 × 20 = $240,000, your savings target is around a quarter of a million dollars, before adjusting for inflation. Once you reach that goal, your investments will produce enough gains to support you forever. That’s going to be attainable as long as you start early. (Some of these calculations require guesses about the future, such as 8% returns, 13% volatility, 3% inflation, monthly periods, log-normal returns and some income elasticity).

The following chart shows the importance of starting your savings young. In the left column, find the number of years until you retire. Then look at the highlighted number across from that. That is the percentage of your retirement budget that you need to continuously save. For example, suppose you are going to retire in about 30 years. The highlighted number in the correct row is “43.3%.” That means that in order to live off of $1,000 per month, you need to save $1,000 × 43.3% = $433 per month.

Years |
Pessimistic | Neutral | Optimistic | ||||

-2 | -1.5 | -1 | -0.5 | 0 | 0.5 | 1 | |

5 |
462% | 437% | 412% | 389% | 367% | 346% | 326% |

10 |
228% | 210% | 193% | 178% | 163% | 150% | 138% |

15 |
145% | 131% | 118% | 106% | 95.8% | 86.1% | 77.3% |

20 |
102% | 90.9% | 80.5% | 71.2% | 62.9% | 55.4% | 48.8% |

25 |
76.4% | 66.6% | 58.0% | 50.5% | 43.8% | 37.9% | 32.8% |

30 |
58.8% | 50.5% | 43.3% | 37.0% | 31.6% | 26.9% | 22.9% |

35 |
46.2% | 39.1% | 33.0% | 27.8% | 23.4% | 19.6% | 16.4% |

40 |
36.9% | 30.8% | 25.6% | 21.2% | 17.6% | 14.5% | 12.0% |

45 |
29.7% | 24.4% | 20.0% | 16.4% | 13.4% | 10.9% | 8.84% |

50 |
24.1% | 19.6% | 15.8% | 12.8% | 10.3% | 8.24% | 6.59% |

The highlighted column is appropriate if you want to be conservative and assume that the markets will have moderately poor performance. If you feel like you want to be either more optimistic or more pessimistic, then you can choose one of the percentages in the other columns. The numbers from -2 to 0 to 1 in the column headings are a measure of how optimistic you are. Negative, pessimistic numbers are better, because they leave less chance that market conditions will force you to modify your plans.

As you can see, if there are only 10 years until your retirement, you would have to save a huge percentage of your income to meet your goals. One way to make that possible is to tighten your retirement budget to fit what you are capable of supporting. The only other solution is if you have already been contributing to a retirement fund. If you already have an investment account, then use the following chart to calculate how effective it will be. Find the highlighted number corresponding to the number of years until retirement, just like before. Multiple that percentage by the amount you have already saved. That’s the annual stipend that you’ll be able to draw, even if you don’t save any more. For example, suppose you already have $150,000 saved and you retire in 10 years. The table gives a percentage of “6.0%.” Since $150,000 × 6.0% = $9,000, your existing savings will earn you $9,000 annually after retirement. That’s equal to $750 per month. That means that for your total budget of $1,000, you only need to worry about how to get the remaining $1,000 − $750 = $250 per month. Going back to the chart above, you need to keep saving another $250 × 193% = $482.50 per month.

Years |
Pessimistic | Neutral | Optimistic | ||||

-2 | -1.5 | -1 | -0.5 | 0 | 0.5 | 1 | |

5 |
4.3% | 4.7% | 5.1% | 5.5% | 6.0% | 6.6% | 7.2% |

10 |
4.7% | 5.3% | 6.0% | 6.8% | 7.6% | 8.6% | 10% |

15 |
5.3% | 6.2% | 7.2% | 8.3% | 10% | 11% | 13% |

20 |
6.2% | 7.3% | 8.7% | 10% | 12% | 15% | 17% |

25 |
7.2% | 8.7% | 11% | 13% | 16% | 19% | 23% |

30 |
8.5% | 10% | 13% | 16% | 20% | 24% | 30% |

35 |
10% | 13% | 16% | 20% | 25% | 31% | 39% |

40 |
12% | 15% | 19% | 25% | 32% | 40% | 51% |

45 |
14% | 18% | 24% | 31% | 40% | 52% | 67% |

50 |
17% | 22% | 29% | 39% | 51% | 67% | 88% |

The important thing is to get started. Even if you don’t have a good idea of a realistic budget for your retirement, a rough estimate is better than nothing. The figures above are also only estimates, but they are accurate enough to be useful. Eventually you can talk to a financial planner to get more precise personalized recommendations, and to plan for other variables like a child’s education fund. Meanwhile, if you are following this formula, you know how much of your money is needed for savings and how much you can afford to play with. You can feel peace of mind knowing that you will be able to pay for your retirement plans and you will never outlive your savings.