This is a very frequent question on this blog and the answer is that
- If you need your money to last 30 years and you invest it 100% in index funds and you withdraw your annual expenses every year, you need 25 times as much money in index funds as your annual expenses (including taxes).
- If you need your money to last 60 years instead and follow the same procedure, you need 33 times as much money.
The way this is calculated is by looking at many different historic trajectories of the stock market and presuming that they will be representative of future market behavior (this may not be true!). The procedure is simple. If you want to check a 30 year period, pick one, say 1971-2001. Investing everything, say $1,000,000 in a virtual portfolio. If the market went up by 5% and you withdrew $40,000, you will calculate 1,000,000*1.05-40,000 = 1,010,000 for the next year. And so on. You will do this for many periods to get a representative idea of your possible future. This is made simple using tools like firecalc.com. All you need to do is to enter the amount of years the portfolio must last, its initial size, and your annual expenses.
The numbers above will be different (lower) if you possess superior investment skills which can be maintained throughout the period. I don’t.
The required size of the portfolio will be lower if you can reduce your expenses. This is the approach I advocate. If you can reduce your annual expenses by $4,000, this means $100,000 less to save for retirement which depending on your income could reduce the number of years before your retirement by several years.
Originally posted 2009-08-23 00:02:49.