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Picking Apart the "25 Rule"

September 23rd, 2008 at 07:01 pm

A couple of people commented on yesterday's post, suggesting the rule of multiplying your desired retirement income by 25 to get the nest egg you need. I understand this argument, that by assuming you get a 4% return on investment, you need 25 times the amount you need.

The problem with it is that I don't intend to die with a $1000000 nest egg - I intend to die as close to broke as possible!

Let's crunch a few more numbers, using my own example. Our monthly expenses (without mortgage) run about $3100 right now. Multiplying that by 12, then 25, I get $930000, just shy of a million. At my current savings rate, I'd need to save for 14.5 years to get there. Using a safe 4% rate of return, this would work fine - 4% of $930000 is $37200 annually, or $3100 a month.

Now let's assume that I want the same $3100 payment every month, but the future value to be zero. Excel tells me that the present value (the amount when I retire) needs to be $459840.82, less than half the amount. I can save that in nine years.

Wouldn't you rather retire five years earlier?

Crunching the Numbers on Going Solar

September 23rd, 2008 at 07:18 am

We're considering adding solar power to our house, in two ways; photovoltaic cells to generate electricity, and a solar hot water system. This also means upgrading the electrical panel in our 96-year-old house.

The total cost will work out to be about $30,000 Cdn. (We can do it in four phases - roughly $3K for the electrical upgrade; $11K for the first KW of PV; $9K for the next KW; $7K for the solar hot water.)

Because we live in Canada, we can't do the cheaper methods of solar hot water, where the water itself is circulated up to the roof. We have to go with the more expensive glycol-circulation type, where an anti-freeze-like substance is circulated and brings heat down to the basement to heat the water.

We pay about $85/month for electricity. We'll tie the electrical into the Toronto Hydro grid with their Standard Offer Program, which might allow us to actually get money back when we generate more electricity than we use. In the simplest scenario where we pay nothing for electricity, it's going to take at least 20 years for the system to pay for itself.

There are two big incentives for me to go ahead and do this, since the payback is so long it's not really incentive;
1. It's the right thing to do for the environment.
2. This is a perfect example of a way to pay now, while we have income, to cut our household expenses when we're retired. If we don't have to worry about electrical price increases from 2016 to 2060, that's one less thing to worry about and plan for.

EDIT: scfr brings up a good point, about tax rebates. We can get the provincial sales tax (8%, or $2400) reimbursed, and there are $1000 in provincial and federal rebates available on the solar hot water system.

The "Millionaire" Cachet

September 22nd, 2008 at 02:57 pm

The biggest problem I had with the book Smart Couples Finish Rich was that it mentions the figure of "a million dollars" throughout the book. In almost any discussion of how much an amount could grow to, the example of how long it would take to reach a million dollars was invariably the calculation that was shown.

This fixation on being a "millionaire" has two problems, in my mind; on the one hand, you might not need a million dollars, and on the other hand, you might need a whole heck of a lot more.

This randomly picked online retirement planner tells me that I need to save 35% of my income between now and age 65, to maintain 60% of my income afterwards (which is low compared to what most sites recommend). A little bit of calculation in Excel shows me that I would have saved $1,938,438.17 by the day I turn 65... just a little shy of $2 million. So, for anyone who wants to retire "well", a million may not cut it at all.

On the other hand, saving and investing a couple of million dollars makes a lot of money for banks and investment brokers. My husband and I are closely tracking and actively reducing our household expenses, and hoping to need only about 35% of our income post-retirement. The total figure to save for that, according to Excel? $664,622.80 - only two-thirds of a million.

So, don't be misled by the idea of being a "millionaire". If you're living the American dream, a million in the bank isn't necessarily going to buy you a retirement with a cottage, golfing every day, and twice-yearly cruises. But by the same token, if your hopes are more modest, you need never be a millionaire to be happy.

9 Things That Helped Me Get in Control

September 21st, 2008 at 10:53 am

This contest is a perfect opportunity for me to capture some of the best resources that have helped me the most in recent months. Most of these are books or websites that have been key to me getting my financial situation in control.

1. The book "Your Money or Your Life" by Joe Dominguez. This was an eye-opener for my husband and I - that we could win the "money game" not by having a lot of money, but by not needing a lot of money.

2. The "Get Rich Slowly" blog. JD's writing style and learn-with-me attitude are refreshing, readable, and useful.

3. Quicken software, to download our transactions and find out exactly where our money goes each month.

4. The ETrade Canada website, where our extra cash is now earning 3% rather than 0%, and we've started buying corporate bonds.

5. The Canadian edition of the book "Smart Couples Finish Rich", by David Bach. This book filled in the gaps from the book mentioned above, helping us to figure out what our values as a couple are.

6. The Service Canada website, which goes through a detailed analysis and predicts how much income you'll get once retired. This helps cut through the confusion around OAS, CPP, RRSP income, and pension income to come up with a full scenario.

7. A variable-rate mortgage with larger-than-necessary weekly payments. At the current rate of 4.25%, the bulk of the money we pay every week goes to the principal, rather than interest. We'll have it paid off in 53 months.

8. The website CalendarBudget. I put in our regular recurring expenses at the beginning, and I adjust them as I go along. It tells me what our cash flow situation is every day into the future, helping me plan expenditures and letting me know when there's a little extra to siphon off into our high-interest account before it gets spent.

9. The book "In Your Best Interest", by Hank Cunningham. Finally bonds made sense to me, and we have started buying corporate bonds on the ETrade site to fund our early retirement (up to age 65 when our pensions kick in).