Following are three simple formulas that can help you know if you are saving and spending appropriately. These shouldn’t take the place of a comprehensive financial plan as these metrics can be inadequate (or even wrong) in some specific situations. These are based on well-known rules of thumb but I have improved (i.e. complicated) them so they apply to a wider range of situations.
Savings Rate. The traditional rule of thumb is that in order to maintain a retirement lifestyle similar to what it was prior to retirement, retirement savings should be 10% of your income. In my opinion this is correct for people with modest incomes, but I think the rule can be improved.
My rule of thumb would be 10% of income plus 1% for every $10,000 of income over $50,000 but not more than 25%. For example, if an individual’s income is $70,000 per year, the savings rate should be 10 + (7 – 5) = 12%. If the income level is $200,000 the savings rate should be 10 + (20 – 5) = 25%. Households with incomes over $200,000 can remain at 25%.
The reason for my adjustment is that Social Security provides a substantial amount of a lower earner’s retirement income but much less of a higher earner’s.
Spending Rate. The traditional rule of thumb is that retirement spending should be no more than 4% of initial portfolio value (and then be adjusted annually for inflation). In my opinion this is roughly correct at the beginning of retirement but of course becomes increasingly wrong as the retiree ages.
My rule of thumb would be spend no more than your portfolio value divided by 60 minus half your age. In other words, at age 66 that would be 60 – 66/2 = 27. So you shouldn’t spend more than 1/27th (roughly 3.7%) of your portfolio at that age. At age 90 it would be 60 – 90/2 = 15 (1/15th is roughly 6.7%).
You could also use the IRS required minimum distribution tables which are similar to my figures. (My version has very slightly higher spending initially, but then gets lower at older ages.)
Home Purchase. The value of your residence should not exceed two and half times your annual income. In other words, if you make $200,000 per year the maximum home value should be $500,000. This simple rule is likely too restrictive in very high-cost locations like San Francisco or Manhattan and of course is inapplicable for retirees.