What’s Missing From This Formula?

June 24, 2008

Quiz time.

Last week while on vacation, I read Brian Tracy’s Flight Plan*, a short little book about success. On page 14 of the book, Brian has this to say about financial independence:

Here’s a simple exercise: Determine how much it would cost you per month to live comfortably even if you had no income at all. Include all your costs of housing, food, travel, medical expenses, vacations, and entertainment. Mulitply that number by 12 (the number of months in a year), and then mulitply that result by 20 (the number of years you will probably live after you retire). The total represents your retirement goal. This is how much you will have to accumulate to be financially independent.

He left out two very important details in his exercise. Do you know what they are?

I know what it is but I can’t say it here because it would defeat the purpose of the quiz. The first person to answer the question correctly (I’m the judge of what is or is not the correct answer) will win a copy of Flight Plan*. Just remember this little contest is only open to U.S. residents.

Good luck.

[Now begin playing “Zeopardy” music…]

*Affiliate Link

45 responses to What’s Missing From This Formula?

  1. How about adding an inflation multiplyer.

  2. inflation multiplier and emergency funds

  3. Phyllis and Anoop,

    You are both very close but not quite there. I’m looking for TWO answers.

  4. Inflation and sources of income that will only be realized upon retirement (e.g. Social Security, pensions, etc.)

  5. I know one would definitely be inflation is not taken into account. Also…we’re assuming the money would be invested, so you could save less up front and then have a rate of return on your investment which would help you achieve your goal. Not sure if that’s the second part that’s missing…

  6. Actually, I can think of three. Inflation, sources of income that will be realized upon retirement, and whether or not the mortgage will be paid off.

  7. He left out inflation and interest.

  8. Seems like he’s missing interest/growth and inflation. And taxes, but without any gains, there aren’t any taxes.

    Maybe he’s assuming that taxes and inflation will pretty much cancel out growth?

  9. You are ALL really close.

    Inflation is one of them. But, I still haven’t found the second part of the equation that I’m looking for.

  10. To me, it seems he failed to mention 3 important things. Inflation, you must account for inflation. Also, that money you save up should be making more money. So he failed to account for earnings from investments. Also, taxes were not mentioned, however… maybe that needs to be assumed?

  11. Inflation and compounding interest

  12. My guess would be that medical expenses are far higher for old people, so going by current medical expenses isn’t useful. Also, there’s stuff like long-term care, etc.

    Another issue is people may well live much longer than 20 years, particularly if some of the life extension technologies pan out. If people live to be 150, the whole idea of “retirement” may have to be completely rethought.

    There’s lots of risks in retirement planning, and not all of them are necessarily “downside” risks.

    Another risk is tax policy risk. I expect that we’ll have consumption taxes fairly soon of one sort or another, and even Roth IRAs can’t avoid those.

  13. Inflation and the fact that many people move to a different location, so housing costs can differ greatly. Or maybe it has to do with the fact that your medical expenses are probably going to be astronomically higher than they are now?

  14. Inflation and compounding interest/the rate you would discount that back today to arrive the amount you need to today

  15. He left out Social Security. It is interesting comment on our times & situation that NOONE ever mentions social security as part of their retirement plan. Inflation of course would be the other component.

  16. I would say inflation and changes in expenses. For example, your mortgage might be 1000 dollars a month, but you may only have 5 years left on the mortgage. So it wouldn’t make sense to multiply this 1000 dollars a month by 20 years.

  17. Joshua Raines June 24, 2008 at 4:14 pm

    I would say its inflation plus the random price of things going up. Such as food and gas because those are all dependent on the economy itself and seems to have a huge impact right now on how people live in retirement.

  18. I’d say he left out a number of things.

    Inflation, interest earned on the savings, taxes on the interest earned on the savings, other income (i.e Social Security), the combined life expectancy of you and your spouse. After all perhaps one of you will die in 20 years, but there is a more than 50% chance that either you or your spouse will live past 90.

  19. Well, inflation is really obvious. So is taxes. But when he mentions medical expenses, most of us have benefits at work that we will not have when we retire. Those medical expenses, along with poorer health, are going to increase dramatically, so additional money will need to be saved.

    Additionally, we should be looking to rebalance to a more conservative portfolio when we get older. As we go from a young age to an old one, the less we can afford the fluctuations in the stock market, and more assets should be put into safer investments, such as bonds, simply to keep up with inflation.

    And if we live past twenty years, then what?

  20. Joshua Raines June 24, 2008 at 4:34 pm

    Oh maybe its inflation plus the fact that he mentioned to take a months worth of expenses. Not all months are spent equally. I will go some months by spending XX on bills but others I will spend XXXX on bills. Things such as insurance which I pay quarterly will affect that. Also things such as gas in the winter for my heater as opposed to the summer.

  21. Also, he has housing listed, but nothing for utilities, which I would consider a separate part of the budget.

  22. Personally, I’d like to live more than 20 years past retirement (: It’s a good exercise, but vastly simplifies the numbers.

    As others have said: inflation, an emergency fund, interest, and taxes all need to be taken into account. Similar to the mortgage suggestion, I would also add that the cost of health care at a younger age will most likely be less than during retirement. Basically, there are changing factors he doesn’t account for that will be different before and after retirement.

    His general categories leave out charity and daily transport (unless he’s grouping that with travel), but then the categories will vary by person.

  23. Darn, I also forgot one other thing…transportation, which is different than travel. The cost of either using public transportation or vehicle maintenance/upkeep/fuel. Even though I am retired, that doesn’t mean I don’t go shopping for groceries anymore. 🙂

  24. Inflation and real rate of return

  25. Jared Jacobson June 24, 2008 at 4:48 pm

    I would say that he left out the following:

    1. Inflation (obviously one you’re looking for, since you agreed to it)
    2. Large one-time expenses that will hit in retirement (e.g. weddings)

  26. The first thing is obviously inflation.

    The second thing I would need to include is not my *current* expenses for medical, vacation, etc., but an understanding of my future lifestyle and expenses. I will spend more money on medical expenses and travel in retirement than I do right now, for example.

  27. Inflation and cost of living?

  28. Inflation and interest after retirement along with extra medical costs since you are older.


  29. I’m going to guess that the missing details are rate of withdrawal, along with inflation. If I need 5% for yearly expenses, but I withdraw 12% the first year in order to finance my trip around the world then there’s going to be trouble down the road…

  30. I agree with a lot of what’s been said.

    He also misses a huge key point by using 20 as the multiplier. Forget life expectancy for a minute.

    It’s generally accepted that you can safely take ~4% of your starting principal each year and not lose ground to inflation. Thus, if you multiply by 25 instead of 20, you have an excellent chance of never running out of money no matter what your life expectancy.

  31. Everyone’s already mentioned inflation…

    But what about “final arrangement” costs (funeral services, cremation, burial, etc.)? Seems pretty depressing, but that IS what’s at the END of retirement, right? And with funerals costing anywhere up to and beyond $10,000, that would be quite a bit of money not accounted for in the formula.

    Unless you’re planning on putting the financial burden of your final arrangements on your living relatives or the state, it’s something to account for when totaling up your retirement goals.

  32. #1 – Inflation.
    #2 – Age you Retire and/or Longevity. That is, 20 years may or may not be enough time to assume depending upon what age you retire. 20 years might work fine if you retire at 70, but not at 55.

  33. I think Jeremy Bettis got the two that JLP was looking for: Inflation and life expectancy.

    As others have pointed out, inflation is a constant tax on your money. As for 20 years, I sure hope I live longer than that after retiring, and I don’t want to live the last few years on nothing but Social Security.


    #32 – Steve Braun

    I was looking for “time horizon” but Steve’s answer was close enough because he mentioned both retirement age (the length of time between now and retirement age)and longevity.

    Leaving out inflation was a no-brainer to all us personal finance junkies. Every commenter noticed that one. You should all pat yourselves on the back because lots of people would have missed that.

    Thanks to everyone who submitted an answer. I’ll try to do more things like this in the future.

  35. I agree that you have the answers you were looking for. However, one could argue that there is a third factor that will decide your ability to live off your retirement savings much more than the other two, and that is the healthcare cost as you age. Many studies have shown that health care costs including the cost of long term nursing care which is barely covered by most insurances can exceed a million dollars in 20-25 years. And I can vouch for it being a doctor in training. Now if this formula uses only the current premiums for perhaps a healthier individual, one can confidently say that even taking into account the inflation and the time frame, one would be way off unless you have protected yourself with a long term care insurance-a very controversial purchase at the best. So I would put the time frame and the healthcare costs as the two most important factors.

  36. I was going to say inflation and compound interest!

  37. Everyone seems to be stating that a 20 year plan is not enough, and also that he left out all compounding interest.

    If you had a full 20 year savings ready to go, then with interest he might be expecting you to live off the interest then you will be able to sustain a longer retirement than those 20 years. I don’t know the math to calculate withdrawl rates that you can life off of and not deplete your savings but 20 years would do a heck of a lot more than 20 total years.

  38. I believe Brian Tracy is using a multiplier of 20 to represent a 5% withdrawal rate – NOT the number of years you’ll be in retirement.

    Assuming you have your portfolio invested in a 60/40 mix of stocks/bonds, a 4-5% withdrawal rate is considered relatively safe. If you do not take large lump sums out for random things (trips, weddings, education for grandkids, etc.), then this formula will generally allow you to die with money left over. The idea is that in your first year of retirement, you withdraw 4-5% of your portfolio. Every year after that, you increase it by inflation.

    If you want to look at what your retirement goal will be for the day you retire, use the formula he gives then multiply it by (1 + inflation rate) ^ years until retirement. The way his formula works you’ll have to recalculate it every year. Once your retirement assets equal the result from the formula, you have enough assets to retire. Obviously, you should reduce your living expense need by any income you’ll be receiving in retirement (Social Security/Pensions/Part-time employment…not portfolio income).

  39. Paul’s explanation of Brian’s rule seems plausible to me. The thing that always confuses me with these rules of thumb exercises is that they never state whether they are referring to before-tax or after-tax dollars. And, of course, it is impossible to know my future tax rate, especially given that my income would be coming from a mixture of investment types.

  40. Inflation and return on invesment

  41. My post from yesterday isn’t here? Anyway, I guessed that the missing details are rate of withdrawal and inflation. In order to withdraw the same amount each year the percentage would always have to stay the same – 5%. But if you withdraw a higher percentage any of those years, then it won’t last the entire 20 years.

  42. Given that he actually said “and then mulitply that result by 20 (the number of years you will probably live after you retire),” I don’t think he was talking about withdrawal rate.

    It seems to us that that’s what he must have meant only because we know better. 🙂

  43. What about changes in taxes (such as property tax for homeowners) or changes in property value (which result in higher property tax payments or higher rent).

  44. Well, perhaps I would have won had I looked at this earlier, yet not being resident in the US I wouldn’t have qualified for the prize anyway, so no worries.

    Before bruising Brian too much, it strikes me that his formula is useful even if perhaps a little erroneous because it sets the cogs turning. His simple formula is not intimidating and approachable… I guess he is reaching out to the frighteningly large number of people who don’t “get it” and never even consider such a formula in the first place!

    Factoring in inflation and time horizon is very important, yet I think Brian simply wanted a quick wake up call to a ball-park figure. Considering the variables out there, perhaps that is all you need. Here are are a few more factors that can pop the dream bubble…”global warming quotient”, as in forget your present fuel bill as any kind of estimate; “Family”, I think Todd gets it with succinct elegance, “Kids” can be a huge factor with major possible pluses and minuses, so are we kidding ourselves to even try to come up with a more accurate estimate?; Health, as many have pointed out is probably the most significant factor… time should be measured in heart beats, yet few ever monitor this on a regular basis or let the “old ticker” provide its wisdom; “Why retire?” My grandfather was working at 85…he went in to recommend a younger employee and met up with an old work friend who saw him in great shape and offered him a part-time job! He wasn’t desperate for money, yet happened to be the kind of chap who enjoyed polishing his shoes in the morning…and watching his grandchildren laugh with the holiday overseas he could then afford to give them 🙂 Then a bus ran him over and though he survived the left leg amputation, the hepatitis from the blood transfusion ended his retirement a year later. Yet I witnessed an inspirational death, which brings me on to yet another factor in the equation one might hasten to mention…”Improvement”…why should we ever “settle” for equations based on our present status, when we might really want to factor in the potential for financial growth at any age. Longfellow had a great bottom line…”Let us then be up and doing, with a heart for any fate, still achieving still pursuing, learn to labour and to wait!”