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.
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 Concerns, Look 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.
Do you enjoy HumbleDollar? Please support our work with a donation. Want to receive daily email alerts about new articles? Click here. How about getting our twice-weekly newsletter? Sign up now.
