Lee Eisenberg is not a fan of rules of thumb. In his new book, The Number, he takes a look at a few of these rules and effectively thumbs his nose at them. The author says:
[M]any financial writers are content to continue to crank out simple but useless rules of thumb. Feel free to ignore them. A solid, reliable Number will not fall out of the pages of a magazine or newspaper. If you’re looking for certainty in a Number, a large factor of you must be added into the equation.
Lee takes a look at a popular calculation whose proponents claim that in order to determine your necessary annual income in retirement for an “acceptable existence,” multiply your latest annual salary by a factor of 0.7. Lee points out that this simplifcation neglects several important factors that can greatly affect the Number, thus greatly affecting the strategy necessary to attain that number.
Here are the missing, difficult-to-quantify variables:
* How old are you now and when will you retire?
* Can you withstand the risk necessary to have a chance at reaching your Number?
* How long do you (and your spouse) expect to live and are you healthy?
* What are the ages of your dependents and will you leave money to them or to charity?
* What is your expectation for income from a pension, and is it indexed to inflation?
* Where in the world do you want to be and stay when you retire?
And most importantly:
* Have you thought about what makes you happy?
The results of some of these questions can be factored into your calculations to a point, but happiness is more of a stretch. While others suggest starting with a simple formula like the oe above, depending on some of these other factors, any calculated result can be way off.
This is the premise of the book. You have to know yourself and spend some time determining what makes you happy before you can make informed plans for leaving the world of active income.
Updated February 6, 2012 and originally published November 30, 2005.