Sunday, March 12, 2006

Financial Formulas

In 1975 I derived a formula for helping me determine what I needed to save as a percent of income to reach a particular goal some time in the future. It could be paying for college, a vacation, home or retirement.

The basic problem was how to take into account inflation. If I saved a set amount each year, I would have to save a large percentage of my income in the first year decreasing yearly (as a percentage of income) as my income increased. What I wanted was a flat percentage to save that would take into account wage growth and inflation.

I have an interactive calculator that allows you to input:

  • Inflation - This is a replacement rate. It is what you escalate yearly costs by. You could use any index, CPI, Dow Jones, SP-500, Wage Growth, etc.
  • Your projected yearly wage growth. This is another type of replacement rate.
  • Your projected rate of return while working.
  • Your projected rate of return while retired.
  • The number of years to save. In this case, your current age minus your retirement age.
  • The number of years you wish to withdraw and adjusted yearly benefit.
How much do you need to save for retirement?

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