LAST REVIEWED Jun 08 2020 8 MIN READ
By The Human Interest Team
If you are a small business owner or someone who is self-employed, planning for your future retirement is something you must manage on your own, as there is no employer involved in the process. Determining the right amount of money that you should be saving each month is key in order for compound interest to work and allow you to reach your financial goals. Fortunately, there are a number of different models you can use to determine the amount you’ll need for retirement, specifically the rule of 300.
Your Way to Financial Freedom
Retirement is one of the most challenging financial goals you will ever have to work toward, as it requires you to anticipate what your daily spending habits will be years or even decades into the future. There is no way for you to truly know what your expenses will be in the future, so it’s difficult to imagine what you’ll be paying for decades from now.
If you’ve ever been overwhelmed by trying to calculate the amount of retirement income you’ll need, then it’s time to stop worrying. There is a fast and easy way to estimate how much you’ll need: the rule of 300.
The Rule of 300
The rule of 300 is incredibly simple. Simply take your current monthly expenses and multiply that amount by 300. The amount you get is how much you’ll need to have saved to keep living the lifestyle you currently lead when you’re retired.
Another way that you can use the rule of 300 is to determine the amount of money you’ll need for retirement, multiply it by 4% and then divide it by 12. For example, if you have $1.5 million in your investment portfolio, and you know that you’ll be drawing 4% per year to use in retirement, you’ll be living off of $60,000 per year. That means you will have enough for $5,000 in monthly expenses.
The 4% Rule
While the rule of 300 allows you to determine how much money you will need to save for retirement, there is one key factor that it does not take into consideration: inflation. However, the 4% rule is a simple solution to this problem.
The 4% rule is based on a study that analyzed data from 1925 to 1995 in order to determine the maximum amount someone could take from their investments during their first year of retirement and ensure they would have enough money, in spite of the fact that the price of goods and services increases during the year. Analysts found that because the market tends to grow by 4% or more every year; you could draw 4% of your investments in the first year, adjust that amount for inflation each year and never run out of money over a 30-year period. The 4% rule assumes that your portfolio will grow by at least 4% every year to accommodate the rate of inflation.
Some people are cynical about whether the 4% rule is a good strategy for retirement planning. Many argue that 4% is too high because it’s based on U.S. investment returns, which are often higher than the global average. Others argue that 4% is too pessimistic.
Downsides of the Rule of 300 and 4% Rule
There are downsides to every forecasting model. While both the rule of 300 and the 4% rule are straightforward and easy to use, neither takes every possible scenario into consideration.
There will always be fluctuations in the market, and there may be situations where the market collapses, like in 2008 and 2009 during the housing crisis, or where the economy takes an expected downturn, such as during the COVID-19 pandemic. If this occurs, it could significantly drop the value of your investment portfolio, which could impact funds you anticipated having for retirement. That said, experts say that a recession is an ideal time to invest in great stocks that you know will yield when the market recovers.
Another downside of forecasting models is that they cannot account for changes in your lifestyle over the years. As The Fifth Person notes, even from the age of 65 to 90, you cannot assume you’ll have exactly the same lifestyle with the same expenditures month after month. Your interests and tastes are likely to change over time, and you’ll need to adjust your finances to accommodate those lifestyle changes.
Even with great health insurance, there is no way to anticipate every possible health care cost you could face when you’re older. Doctors and treatments can become expensive and could quickly deplete retirement income.
Considerations for Retirement Computation
While the amount that you need for retirement can seem daunting, it’s important to remember that compound interest can make even large numbers easily attainable. However, the key is to get started as soon as possible to give compound interest time to get you to that number.
Additionally, the amount you need to achieve financial freedom in retirement may have little-to-nothing to do with your income. In fact, this amount mostly depends on your expenses. By reducing and learning to live with fewer monthly expenses, you’ll reduce the amount of income you need for retirement and reach the amount you need for retirement more quickly since you’ll have more money to invest.
Rule of 300: Bottom Line
The rule of 300 is a simple way to get a general idea of how much money you will need for retirement. While neither the 4% rule or the rule of 300 should be used as the sole determination of how much you will need for retirement, it can help you gain perspective on how close you currently are. Our experts can help you to choose and set up a retirement plan that will help you achieve your retirement goals more quickly. For a free consultation, contact us today.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.