Would you like to retire at 60? Depending on your age, you won’t be able to receive the State Pension until you’re between 65 and 68, under current rules.
In the meantime, you’ll need another source of income. In this article I want to explain how much you’re likely to need and suggest two ideas to help you build a retirement fund.
How much will you need?
The first thing to do is to work out how much you will need to live on each year. This needs to cover your household bills, travel costs and shopping, plus an amount for hobbies, holidays and leisure activities.
Once you’ve worked out a yearly figure, then we can use a simple trick to estimate how much you’ll need to have in your retirement fund. This is known as the 4% rule.
Most financial advisers use the 4% rule to calculate how much you’ll need to fund your retirement. The rule says that if your fund is invested in stocks and bonds, you should be able to withdraw 4% each year for at least 33 years, without running out of cash.
For example, if you want an income of £20,000 per year, the 4% rule suggests you’ll need £500,000. For an income of £30,000, you’ll need £750,000.
How to get the cash
I believe the best way to build a retirement fund is by regular saving into the stock market throughout your working life. But if you expect your retirement savings to fall short of what you need to retire at 60, then I have a couple of other suggestions.
If you’re a homeowner and have paid off your mortgage, then you could consider an equity release product. These are sometimes known as reverse mortgages, because they provide cash now and require a lump sum repayment when the property is sold.
The details can vary. But as a general rule I’d expect that repaying your equity release product will require most of the proceeds from the future sale of your home. So it’s not ideal if you’d like family to inherit the house.
Invest like Warren Buffett
In my view, the best way to build a retirement fund is to put as much spare cash into the stock market as possible when you’re younger. You can choose to invest in individual stocks or simply put cash into an index tracker, such as a FTSE 100 tracker fund.
I believe the secret to success is to follow the same approach used by Warren Buffett. Buy good, profitable companies that produce plenty of spare cash. Hold the shares for a very long time. Reinvest the dividends each year until you are ready to retire, when you can draw them as income.
How much should you save each month?
According to Barclays, the UK stock market has delivered an average annual return of about 8% over the last 100 years or so.
At that rate, my sums suggest that building a £500k retirement fund over 20 years would require payments of about £850 per month.
If you’ve got 30 years until you want to retire, these payments fall to around £335 per month.
This is a great reminder that the best way to make money in the stock market is to start early and let market returns do the work.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.