Crunching the Numbers to Meet Financial Goals

Individuals who are saving for retirement or a child’s college education face one nagging question: How much money will they need?

One financial adviser may say that a middle-income family will need to set aside at least $1 million to maintain its standard of living through retirement. Another may put the number at half that amount.

To make matters more confusing, the adviser who wants you to have $1 million set aside may suggest that you save just $300 a month to get there, while the other adviser may suggest monthly savings of $500 to accumulate the $500,000 nest egg.

The same holds true for those pushing college accounts. Given the same facts, the answers often vary by thousands of dollars.

Most people who are serious about retirement or college don’t find these disparities amusing. After all, the difference between $1 million and $500,000 is a fortune.

And the difference between saving $300 a month and $500 a month can mean the difference between having a social life or having a VCR.

As a result, it may be germane to talk about where these discrepancies come from and how consumers can determine on their own how much they need to save for big-ticket items, such as retirement.

It is still wise to see a financial adviser when contemplating such important and costly events.

But knowing how the adviser comes up with his or her numbers should help you weigh his or her skill.

It will also allow you to periodically check on how your savings and investment plans are working out.

To determine how much you need for retirement or college, advisers make various assumptions based on your lifestyle, life expectancy and economic conditions.

They then plug those assumptions into a present-value calculation. The present-value calculation is a touch intimidating, but it’s not difficult once you get the hang of it. The assumptions are the hard part.

To illustrate, let’s look at a hypothetical 35-year-old man who wants to retire at age 60. His life expectancy is 75 years. And he wants to have the equivalent of $2,000 a month, in addition to his pension and Social Security, to live on when he retires. We will assume that this person can earn 4% more than the rate of inflation on his money. (That’s the same as assuming inflation is 4% annually and you earn 8% annually on your investments. But you save a step by using a simple inflation-adjusted number.)

What we want to know is: How much will he need to have in the bank on the day of his retirement to generate that kind of return and how much does he need to save monthly to get there?

To figure the result, you’ll need a calculator with a present-value function. (I’m using a Texas Instruments BA-35, which sells for under $25. But any present-value calculator will do.)

Now it’s just a matter of plugging in the numbers. First, we know that $2,000 is the amount this man needs monthly. Hit 2000, pmt.

Our interest rate is 4% annually, but since the calculator figures periods by the month, we’ll divide that by 12. The result is .3333. Hit .3333, %i.

He’ll need that $2,000 each month for 15 years (75 minus 60), so hit 15 times 12 (months) to get 180, and hit “n” on the calculator, which stands for number of periods. Plug in a zero for future value, since we’re not calculating that yet. And then hit compute (cpt) present value (pv). The result: $270,384.

That’s how much he’ll need to have in the bank at age 60 to generate $2,000 in income for the rest of his life.

How much must he save each month from now until retirement to get the $270,384?

The $270,384 is the future value we want, so plug in that number and hit future value (fv). He has 25 years, or 300 months, to reach that goal, so we put in 300 “n”. We’ll figure that his investment return will always beat the rate of inflation by 4%. So hit 4 divided by 12 (months)--.3333--and %i. We’re not doing a present value calculation, so plug in 0, pv. Finally, hit compute (cpt) payment (pmt). The result: He has to save roughly $526 per month.

Obviously, every time you change one assumption, the answers all change as well.

What happens if this man retires at age 65? He’ll only need to save $197,540, or $285 monthly. (Remember, he has 60 more months to save.)

What if he earns 8% over the inflation rate on his investments and retires at 65? He needs to save just $164,843, or $111 a month.

What if he retires at age 55 and earns only 2% over the rate of inflation? He needs to save $395,348, or $1,341 monthly for the next 20 years.