This site helps you with all sorts of useful knowledge: How to budget, how to invest, how to establish a good credit score. That’s stuff you need to know today, if not yesterday! But this article is going to be a little different. We’re going to be looking at net worth targets, specifically for those who plan on eventually retiring. We will also explore what the average net worth by age is so you can see where you are.
Do you plan to retire? Like, do you actually have a plan? Remember, you’re going to die one day–memento mori–and you might want some free time before then.
While I think comparison is generally overrated–and it’s certainly a thief of joy–I also believe that comparison has important uses. Comparisons can provide useful information about where you stand next to your peers, which can lead to important suggestions about how to change your financial behavior.
Today’s exploration of net worth targets and average net worth by age is unique. We’re going to see the average net worth by age before we jump in and discuss typical retirement goals. And then we’ll look at how net worth targets play an important role in compiling your desired retirement nest egg.
Average Net Worth By Age
You can use this net worth calculator to help you see your net worth.
Retirement Goals: The Precursor for Net Worth Targets
“How much do I need to retire?” is a million-dollar question. Literally.
Multiple inputs are required to reach an answer. When do you want to retire? What lifestyle do you wish to lead? What’s your risk tolerance? How well do you believe your investments will perform?
And then, especially for younger people, some questions seem too far off to contemplate. What might Social Security look like in 20, 30, or 40 years? Will you be able to depend on it? Similarly, what will the nation’s medical infrastructure look like, and how much of your retirement spending will be devoted to said medical care?
How can we answer all these questions in order to find useful net worth targets?
Thankfully, some of the hard work has already been done for us. According to the Bureau of Labor Statistics, the average (mean) expenditure by a person 65 years old or older (what we’ll assume is a retiree) was $28,300** per year as of 2018. This includes food, housing, transportation, entertainment, insurance, taxes…all the heavy hitters.
**Note: if you’re looking at the BLS website, you’ll calculate this $28,300 if you divide the Average Annual Expenditure of $50,860 by the 1.8 people per Consumer Unit.
As you might already know, sweeping statistics are rarely accurate for individuals. And the mean is quite sweeping. You’ll likely spend a different amount than $28,300 per year. That’s a given. But the mean helps us identify where the meat of the bell curve lies. And it will help us work backwards towards net worth targets.
Retirement Spending Per Year
We’re going to examine Average Joe and Average Joan, an average couple who will spend two portions of $28,300 per year in retirement. Bust out those calculators—I get $56,600 per year.
Well…at least I would get $56,600 per year based on the 2018 data. But Joe and Joan are going to retire sometime in the future.
How do we project their spending rate out into the future? We use rates of inflation. Inflation, if you’re unfamiliar, is a well-understood economic process that boils down to this: prices tend to rise over time, which means your dollar today won’t buy quite as many goods tomorrow.
Joe and Joan’s lifestyle will cost a little bit more now than it did in 2018. Annual rates of inflation typically fall between 2% and 3%. Let’s use an average rate of 2.5% for today’s examples.
In 2020, therefore, we’d expect Joe and Joan to spend ($56,600 * (1.025) * (1.025) = $59,500. Math explanation: multiplying by 1.025 represents our 2.5% inflation increase, and we do that twice to represent two years between 2020 and 2018.
But we probably shouldn’t stop there. Are Joe and Joan going to retire in 2020? Or is their retirement date well out into the future? Each year between now and their retirement date will require another multiplication of 1.025. We can shorten the math to $59,500 * (1.025^N), where N is the number of years from 2020 until retirement. Let’s continue the example.
If Joe and Joan are 40 years old and want to retire in 2039 at age 59 (when they can access their Roth IRA and 401(k)), then their N equals 19. They’ll retire in 19 years when they’ll be spending $59,500 * (1.025^19) = $95,100— that’s quite a bit higher than the 2020 estimate of $59,500!!
Converting Annual Spending to Net Worth Targets
We’ve established that Average Joe and Average Joan plan on spending $95,100 per year in their retirement. (At least, that’s what they’ll spend during their first year of retirement, and then inflation will continue to push that number higher. We’ll address this in about 15 seconds)
What do their net worth targets at retirement need to be in order to safely permit that spending?
Enter the 4% Rule. The Finance Twins have covered this rule a few times before. In short, the 4% Rule states:
- If you withdraw 4% of your nest egg in Year 1 of retirement, and then increase withdrawals each year to adjust for inflation…
- And if you invest in a 50/50 mix of stocks and bonds…
- And if you stay retired for 30 years…
- Then your nest egg would have been “safe” for 95% of all previous 30-year periods in the U.S. stock market’s history
Let’s see how Joe and Joan line up with these assumptions.
Will they invest in a 50/50 mix of stocks and bonds? I say yes—hey, it’s my hypothetical!! While many younger investors skew towards the “high risk, high reward” of stocks, many older investors adjust their portfolios to include higher percentages of bonds. 50/50 is a reasonable balance for two retirees.
Will Joe and Joan be retired for 30 years? Seems plausible. After retiring at 59, Joe and Joan would do well to live to the ripe old age of 89.
And finally, how do Joe and Joan make sure that they withdraw 4% of their portfolio in Year 1 of their retirement? They use algebra!
Let’s set up this algebraic equation: $95,100 (remember that from above?) = 4% * X, where X is the nest egg goal. We solve for X by dividing both sides of the equation by 4%. That will show us that X = $2.38 million. In other words, 4% of $2.38 million is $95,100. This would suggest that Joe and Joan’s eventual net worth target is $2.38 million!
Whoa! How do average people achieve net worths above $2 million?
“Discounting” a Future Net Worth Target to Today’s Dollars
How do we take Joe and Joan’s future goal—$2.38 million—and “discount” that value back to today’s dollars? It’s similar to what we did before with inflation, but in the opposite direction.
There are two major contributors that will grow their current nest egg into their future nest egg. Those two contributors are principal and interest.
Every year, Joe and Joan will contribute more of their income towards their retirement nest egg. That’s the principal increase. At the same time, we would expect that Joe and Joan’s investments will appreciate, or increase, in value. That’s the interest portion of their nest egg growth (a.k.a. Compound interest, which you might already be familiar with).
How big will the principal growth be? That answer is different for everyone. Let’s say Joe and Joan try to save $12,000 every year, or $1,000 every month.
How big will the interest growth be? Different sources cite different answers, but a growth rate of 7-8% is fairly standard and reasonable for a balanced portfolio. Let’s use 7.5% for now.
Next? Math time! We need to start at our $2.38 million goal and work backwards to today, taking a step each year that reduces our nest egg by $12,000 worth of principal and reduced the nest egg by 7.5% worth of interest. This equation is a little complex. Let’s define:
- F = final nest egg = $2.38 million
- R = interest rate = 1.075
- P = annual principal increase = $12,000
- N = years until retirement = 19 (same as above)
- C = current net worth target— that’s what we’re solving for!
Then our equation to solve for C will be:
We can plug in our values:
And we find that C = $473,800
That’s it. The math is done. This is what Joe and Joan’s net worth target should be today. This 40-year old couple needs $473K today, and to save $1000 a month for the next 19 years, to meet their retirement goal. If this seems high to you, please keep reading!
Quick review: how’d we find this net worth target?
In review, here’s what we did:
- We decided that a common goal in personal finance is saving for retirement and that it makes sense for net worth targets to be tied to a future retirement.
- Found average data for spending in retirement (it was $28.3K per person per year in 2018) and projected that value out 19 years in the future, assuming that our “example” couple is 40 years old today and would be retiring at 59 (i.e., in 19 years)
- We assumed our couple would be retired for 30 years—a reasonably standard length that enables us to use the “4% Rule” from the famed Trinity Study.
- Used the 4% Rule and our couple’s projected annual spending to create a total nest egg goal.
- We then chose an annual investment principal and annual investment interest rate to discount our nest egg goal backwards into today’s dollars. This shows us what our present net worth target should be.
Drumroll, please! This led us to our 40-year old couple’s current goal of $473,800.
“But what about…?!”
Before you break out the pitchforks and torches, remember two very important caveats here.
First, I chose all these numbers. Some are based on average data from the U.S. government. Others are based on “typical” retirements, on historical stock market data, or simply my own thoughts on what Average Joe and Joan might be like. In other words, this exact scenario will likely not apply to you.
And second, I left out some crucial sources of retirement income, depending on where you live and what you do. For many Americans, their retirements will depend on Social Security and (for public employees) some sort of pension.
These retirement income sources would significantly reduce the burden that Joe and Joan place on investing. Therefore, their present net worth targets would decrease. This is good! It means that Joe and Joan need less than $474K today.
Let’s work through a quick example.
Net Worth Targets, assuming Social Security or Pension
Let’s keep everything the same from our prior example, except that we say that Joe and Joan receive an extra $1,500 per month–be it from Social Security, a Pension, or a combination of both–in their retirement years. This amounts to $18,000 per person per year, or $36,000 total for Joe and Joan. (FYI—Social Security doesn’t start paying out until age 62, and Joe and Joan are going to retire at 59. For the sake of this simple example, please don’t let that fact bog you down).
So Joe and Joan’s 2020 spending of $59,500 would be significantly covered by this additional income. $59,500 – $36,000 means that only $23,500 would now need to come out of Joe and Jane’s pocket. (And yes, Social Security benefits do keep pace with inflation).
Just like last time, we project the $23,500 value out into the future, putting it into 2039 dollars. $23,500 * 1.025^19 = $37,600
Now we use the 4% Rule to find that Joe and Joan need $37,600 / 4% = $940,000 in order to retire. $940K is way less than the $2.38 million we used last time.
Finally, we use our “fancy formula” to discount those retirement dollars backwards into a current net worth target.
And we find that C = $109,400. This is Joe and Joan’s new net worth target as a 40-year old couple.
This is a significantly more benign net worth target than our original $474K.
“But I want to FIRE!”
For the unfamiliar, the acronym “FIRE” stands for “Financial Independence, Retire Early.” In short, it combines huge savings rates with lower spending to achieve early retirement. Today’s math can prove that FIRE is possible and can certainly help find your FIRE net worth targets.
All we need to do is change some of our assumptions:
- FIRE retirees typically lower their spending. Let’s say our FIREee will spend $24,000 (in 2020 dollars) per person per year in retirement. If they want to retire in 2030, then their assumed spending will be $24,000 * 1.025^10 = $30,700
- FIRE retirements are designed to last from a young age (sometimes less than 40 years old!) through death. The retirement is longer than 30 years, which means we have to use something more conservative than the 4% Rule. Let’s use a “3% Rule” instead. Our nest egg goal, therefore, is $30,700 / 3% = $1.02 million
- For our “fancy formula,” a few variables change. Our FIREee wants to retire in 10 years, so N = 10. But like many FIRE fans, our FIREee is saving way more than normal— we’ll say P = $30,000 per year. Our value for R remains unchanged.
Let’s plug and chug:
And we find that C = $273,500
Our 30-year old FIREee should consider their current net worth target to be $274K if they hope to meet their “FIRE number” by 2030. While that’s pretty high for the average 30-year old, we’re also talking about someone who wants to cut the total length of their career in half. These are significant changes from normalcy.