Saving for retirement. Sounds fairly simple, right? Earn a bunch of money. Stick it in accounts earmarked “Retirement” and you’re done! Actually, this isn’t far from the truth. It really is simple. Let’s see how.

## Working Your Way Backwards

In the previous post on this series, we learned how to figure out how much you need for retirement. Once you know your “Number”, you work your way backwards from there.

For purposes of discussion, we used $120,000 a year of retirement expenses- which, at a 4% withdrawal rate, translates to $3 Million nest egg that you need to accumulate.

How do we figure how much you need to save as you go along to get there?

## Factoring In Inflation

If you recall, we did not account for inflation when we came up with the $3 Million figure. Which means, that’s $3 Million in 2020 dollars. 20 years down the line, when you expect to retire, that amount will not buy us you much. If you want the purchasing power of $3 Million 2020 dollars, you will need $4.9-$5.4 Million 2040 dollars.

I used this Inflation Calculator at SmartAsset.com, using 2.5-3% projected inflation rate. No one knows what the real inflation will be in the next few decades- but this is the average it has been in the last 30 years (2.5%) and 100 years (3%).

This is one way to go about it- to consider saving up the inflation-adjusted amount you will need.

Another way is to account for inflation when calculating your investment returns. That is, using real returns instead of nominal returns. If you do this, you do not need to adjust your nest egg number for inflation.

## Nominal vs Real Returns

If your investment makes $10 on $100, that’s a 10% *Nominal* return.

If at the same time, inflation was 3%, your *Real* return will be (10-3) or 7%. In other words, your purchasing power went down with inflation- hence the $10 of return was worth only $7 at the end of it.

Nerd Alert: This is actually a shortcut. The real mathematical formula is:

Real Rate of Return = [(1+ Nominal Rate)/(1+ Inflation Rate)] – 1

Fortunately, the shortcut works pretty well that you do not have to bother with the formula.

## Annual Savings Rate

So, you need to have $3 Million in your retirement accounts in 20 years. Since we have not adjusted this number for inflation, you need to use real, not nominal, rate of returns to get there.

If you are starting at zero today, let’s see how much you need to save annually.

Our assumptions:

- Nominal rate of returns on our portfolio: 7%
- Rate of inflation in the next 20 years: 3%
- Real rate of return: 4%
- Years to Retirement: 20
- Beginning balance: $0
- Ending Balance/Goal nest egg : $3,000,000

With these assumptions, we solve for now much we need to save annually.

For this, we will use the Payment (PMT) function on Google sheets. MicroSoft Excel can do the same thing. I’m not the spreadsheet type and was scared of this for years. But it really isn’t scary. If I can do it, you certainly can.

Start with =PMT and hit enter. Hitting the pop-up takes you to the formula help. If it does not automatically show up, try clicking on the (?) “Turn on formula help”.

This is how the formula helps looks:

Now just follow instructions.

- Rate refers to rate of return.
- Number of periods here are the number of years to retirement
- Present Value is the beginning balance
- Future Value is the ending balance we are hoping to accumulate
- It makes a small difference whether you put in the deposits at the beginning or the end of each period. That last variable is optional- and we will leave it at the default for now. So you can ignore it.

To enter each value, just click on the respective cell followed by a comma.

When you have entered all your assumptions, close the bracket.

And hit enter.

This tells us that if you are starting with nada, and want to get to $3 Million in 20 years, with your investments growing at 4% real a year, you will need to plow in a little over $100,000 a year to get there.

Of course, garbage in, garbage out. All results are only as good as our assumptions. Feel free to modify them if you like. If 4% is too pessimistic for you, go up to 5 or 6%.

Once you have this down, play with the calculator as much as you like. Warning, it can a little bit addictive.

What if you think you can make 5% real returns from the market? Well, you need to save ten grand less a year.

What if you want to exit at 15 years instead of 20? How much more would you have to save annually?

About 1.5 times more. FIRE, here we come!

What happens if you don’t stop at 15 years, but keep going for 20? This uses the Future Value (FV) function of the spreadsheet.

Solving for it…. you accumulate $4.5 Million.

What if you are not quite at the beginning but have $250,000 already saved up? You will get to goal by saving about $82,000 a year.

[Remember to use a minus sign before your Present Value.]

But what if you can only save $50,000 a year? Maybe you have student loans or other high-interest debt. Or not a high-enough income to shovel away a hundred grand a year. Then it will take you a decade longer. 11 years to be exact.

This uses the NPER (number of periods) function in spreadsheet. Works exactly the same way as the PMT function. Just remember to put a minus sign in front of your annual savings (payment) argument.

## Is The 20% Rule Good Enough?

Saving 20% of your gross income towards retirement is a popularly quoted rule of thumb. It is a good place to start before you’ve figured out where life is taking you. But the sooner you can fine-tune it, based on *your* goals, the better off you’ll be.

This is because every’s situation is so different. Some variables that come to mind:

- Physician income vary from 5-figures to 7. 20% of a $90,000 part-time pediatrician’s salary will take you to a very different place from 20% of a $1 Million Orthopedic surgeon’s income.
- You may have other sources of income in retirement that most people don’t- a sizable inheritance. Or a pension, perhaps (though it may be wise not to count on those. If you get them, hurray. If you don’t, you’re not homeless in old age).
- You may have student debt to deal with. Or consumer debt.
- Everyone’s timeline is different. You may have graduated late. Or you may want to get out particularly early. Or you really love your job, are in no hurry to quit.
- Returns will vary. Based on market ups and downs at different points in your accumulation period. If the market is low early in your savings period, you get to buy a sale and your total losses are less. If you hit a long stretch of poor market returns when you are closer to retirement, it sets you back to a larger degree. Based on your asset allocation. Based on tax drag in your accounts.
- Investor behavior plays a big role in returns. Market timing. Having a large uninvested cash reserve. Having an unreasonable portfolio. Performance chasing. Tinkering with your portfolio. Panic selling during a market downturn. All sins that cause you to give up gains.

For these and other reasons, I prefer the “Work Your Way Backwards” method. Set your goal. Then you know what you have to do to get there. If this is written down neatly on a piece of paper, it becomes the beginning of your Investor Policy Statement.

Please remember, though, these are estimates. you will need to reassess how things have been doing and recalibrate as required.

## Where do You Save for Retirement?

Wherever you can. But there is some method to the madness.

- If you have access to workplace retirement accounts, those buckets are the first you should fill. Their advantages are many: tax savings upfront, tax-deferred growth, tax arbitrage between your high tax rate now and likely lower tax rate in retirement. Maybe your employer gives you a match. As an employee, you get to put in $19,500 (in 2020) into a 401(k) or similar retirement account. If you own your business, you get to shove in $57,000 into it. More if you have a Cash Balance Plan.
- Next comes the Roth IRA- either done directly, if your income is low enough or through the Back Door, as for most attending physicians. This amounts to $6000 each for self and spouse.
- If you have an HSA, it has triple tax benefits: an upfront tax deduction, tax-free growth and tax-free withdrawal for eligible medical expenses down the line. The maximum HSA contribution for a family in 2020 is $7100.

This brings us to a total of $32,600 for an employed single doc or $38,600 for a married couple. So, you may have some more savings to put in towards retirement.

These can go into a regular, taxable, Brokerage account. Pick your favorite custodian- Vanguard, Fidelity, TD Ameritrade, Schwab, or other- and set one up.

Automatic periodic withdrawals really work. If you don’t see the money coming in, you don’t miss it either. Plus the cash is not sitting around, waiting for you to invest it. You should be able to set it up for all the above accounts.

Make sure to name your beneficiaries on the accounts when you set them up, too.

Next up, what do you invest in? That is your Asset Allocation. We will need to talk about that in another post, since this one is now long enough. Or too long, depends who you ask.

Questions or comments? I’d love to hear from you. Thank you for reading!