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Sweat the Big Stuff

Adam M. Grossman

I’D LIKE TO DESCRIBE—and recommend to you—what I’ll call the John Cleese approach to financial planning. It is, in my view, the simplest and most effective way to think about saving for retirement or any other goal.

John Cleese, the English actor and comedian, is largely retired. But in an interview, he described his approach to getting work done. When he had a weekly TV show, Cleese said, he didn’t worry about being unproductive some days. “I learned… that no matter the distractions, over a week we’d get 15 to 18 minutes of sketches completed.”

How is this relevant to financial planning? I’ll answer with a brief story. Several years back, I was working with a young couple. A key goal was to purchase a home, and they wanted to know whether they were saving enough. They had good incomes but wondered whether their spending was too high. For example, they asked whether they were spending too much on organic fruit.

My response to the young couple: Instead of looking line by line at your spending, a much easier way is to look at your overall savings rate. Just ask whether you’re meeting your annual savings goal. If you are, it almost doesn’t matter how much you choose to spend on any one item.

You can see the parallel. John Cleese knew he had accomplished enough in a week if he had the 15 to 18 minutes of jokes he needed for his show. In saving for the future, it’s exactly the same. As long as you meet your annual savings goal, there’s very little else to worry about.

This approach, I find, helps cut through a lot of worry. Some families worry whether they can afford a vacation or a particular school’s tuition. Others fret about the mortgage on a new home. But with the John Cleese approach, it becomes much easier to answer any of these questions. Like Cleese, if you know you’re doing what you need to do on the savings side, you can do as you please on the spending side.

How is that savings rate calculated? There are six steps:

Step 1: Estimate your retirement date. For this example, let’s suppose you’re age 40 and want to retire in 25 years.

Step 2: Determine how much you’ll need to withdraw from your portfolio each year in retirement. This step requires a few calculations, but it shouldn’t be difficult. Start with your current annual spending. Then subtract the expenses you don’t expect to have later in life. These might include childcare or school tuition. It might also include your mortgage, which ideally would be paid off by that time.

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Next, be sure to increase this number to account for inflation, which might be 2% or 3% a year. You should also take into account Social Security and any other sources of income you expect in retirement. The net of these numbers will be the sum you would need to withdraw each year from your nest egg. Suppose you would need $100,000 a year, including money earmarked for taxes.

Step 3: Estimate your required nest egg. For simplicity, start with the 4% rule and use that to calculate how big a portfolio would be required to safely generate this $100,000 a year. If you divide $100,000 by 4%, that translates to $2.5 million. That’s the nest egg you would want to amass by the first day of retirement. (I should note that the 4% rule is hardly gospel, but it provides a useful ballpark figure.)

Step 4: Tally up the savings you’ve already accumulated. If you’re mid-career, let’s assume you have $300,000 saved.

Step 5: Calculate how much you’ll need to save each year. Let’s assume you expect to earn a 5% annual return. Enter that 5% plus the numbers above—25 years to retirement, $300,000 currently saved, $2.5 million needed at retirement—into a spreadsheet using this formula:

= PMT(5%, 25, -300000, 2500000)

If you plug that into Excel or Google Sheets, the answer you get will be about $31,000. That’s the amount you’d need to save each year to reach your retirement goal using the above assumptions.

If you run this calculation and the resulting figure appears dauntingly high, don’t despair. You should view this figure as an average. If you’re early in your career, you can start at a lower number and then increase it over time as your income grows.

Step 6: Stress test your results. You’ll notice that each number I’ve used here was an estimate. They might be reasonable, but nonetheless they’re estimates. For that reason, I recommend conducting stress tests. For instance, you try out a higher spending number or a lower estimated investment return.

This is useful for two reasons. First, you’ll get a sense of the relative importance of each variable. As you experiment, you’ll see that some matter much more than others. Second, while I recommend boiling your goal down to a single number for planning purposes, it’s important to first consider a range. For example, you might find that your plan will probably work with a savings rate of $30,000, but it will almost certainly work with savings of $40,000. Whether you choose to plan on the lower or the upper end of that range will depend on what’s feasible given your budget today and your willingness to take risk. But it’s important to start by knowing what those lower and upper bounds are.

To be sure, there are other considerations that go into financial planning. But as a framework for managing your financial life today to help you get where you want to go tomorrow, I can’t think of a more useful way than the John Cleese way.

Adam M. Grossman’s previous articles include Emerging ConcernsLook Under the Hood and Follow the Fed. Adam is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman.

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David Powell
David Powell
10 months ago

Good one! For calculating a retirement income goal remember to also back out your annual savings for retirement while working, and add in costs likely to be higher in retirement like travel in the first half and healthcare in the last.

R Quinn
R Quinn
10 months ago

If only more people would take the time to follow this advice. I am amazed how often I hear, “I can’t save that much” or “I can’t afford to save” after I hear that I look at their spending and sometimes I have to bite my tongue. To make planning simple and IMO for practical reasons, I say the income goal in retirement should be 100% of base income while working, no offsets because new expenses will pop up or be desired. And I maintain you should be able to save in retirement to deal with cash emergencies and not disrupt retirement assets.

parkslope
parkslope
10 months ago
Reply to  R Quinn

A couple’s income and expenses in retirement are usually so different from what they were while working that I find the 100% of base pay guideline of little use.

Langston Holland
Langston Holland
10 months ago

One thing I’ve noticed in life across every discipline I’ve been involved with is that mastery of a complex topic is best demonstrated by the ability to explain it in simple terms without compromising the particulars.

Boiling things down to their essence requires genuine understanding and it provides the extremely beneficial service of highlighting what really matters. This article is an example as is Buffett’s subordination of budgeting to “Don’t save what is left after spending, but spend what is left after saving.”

I do wonder about the modern American mindset in reference to retirement. While most are motivated in their early years to live above the lifestyle provided by “welfare”, it seems that many reverse this decision when it comes to their retirement years. Maybe they trust that their children will take care of them, or that their politicians will place the children of others in this role. Maybe it’s just short-sightedness, or real or perceived inability.

Whatever the case, the information needed to do better is out there (like here) for the picking.

/rambling

Roboticus Aquarius
Roboticus Aquarius
10 months ago

It’s amazing how closely we were able to forecast our eventual savings when we were in our late twenties… a couple decades later, we are right on track. What was much harder was figuring out how much we would want/need in retirement. We’re now targeting 2x in retirement savings vs our target of decades ago. Having had most of a pension eliminated, and incurred special health costs, our needs (and wants) have increased. It’s a good thing we built in plenty of wiggle room built into our planning.

It’s difficult to understand what unexpected things will happen to you over the decades. It’s seems to me that it’s best to start with multiple contingencies, and then decide whether to whittle those away as you go along.

parkslope
parkslope
10 months ago

Agree. While we played around with guidelines when we were working we never got around to setting a specific target. Our approach was simply to maximize our retirement income while living a modest but comfortable lifestyle. Key factors for us were maximizing our 403(b) contributions, delaying SS until 70, working until 70 and allocating a substantial share of our investments to equities in index funds, alhough we never went above 60% because of low risk tolerance.

Bob T
Bob T
10 months ago

I appreciate this article. I’ve found a version of this approach effective – pay yourself first – and automate it.

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