I’d like to describe—and to recommend to you—what I’ll call the John Cleese approach to financial planning. It is, in my view, the simplest and most effective way to think about saving for retirement, or for any other goal.
John Cleese, the English actor and comedian, is largely retired now. But in an interview, he described his approach to getting work done: When he had a weekly TV show, Cleese said, he didn’t worry about being unproductive some days. “I learned…that no matter the distractions, over a week we’d get 15 to 18 minutes of sketches completed.”
How is this relevant to financial planning? I’ll answer with a brief story: Several years back, I was working with a young couple. A key goal was to purchase a home, and they wanted to know whether they were saving enough. They had strong incomes but wondered whether their spending was too high. As an example, they asked whether they were spending too much on organic fruit. It seemed like a minor point, but it revealed how important it is to have a framework for financial decision-making.
My response in this case: Instead of looking line by line at your spending, a much easier way is to look at your overall savings rate. Just ask whether you are meeting your annual savings goal. And if you are, it almost doesn’t matter how much you choose to spend on any one item.
You can see the parallel. John Cleese knew he had accomplished enough in a week if he had written the 15 to 18 minutes of jokes he needed for his show. In saving for the future, it’s exactly the same. As long as you meet your annual savings goal, there’s very little else to worry about.
This approach, I find, helps cut through a lot of worry. Some families worry whether they can afford a vacation or a particular school’s tuition. Others might worry about the mortgage on a new home. But with the John Cleese approach, it becomes much easier to answer any of these questions. Just like Cleese, if you know you’re doing what you need to do on the savings side, then you can do as you please on the spending side.
How is that savings rate calculated? These are the steps:
Step 1 – Estimate your retirement date: For this example, let’s suppose you’re 40 years old and want to retire in 25 years.
Step 2 – Determine how much you’ll need to withdraw from your portfolio each year in retirement: This step requires a few calculations but shouldn’t be difficult. Start with your current annual spending. Then subtract the expenses you don’t expect to have later in life. These might include child care or tuition. It might also include your mortgage, which ideally would be paid off by that time. Then be sure to increase this number to account for inflation, which might be 2% or 3% over time. Then you should account for Social Security and any other sources of income you expect in retirement. The net of these numbers will be the sum you would need to withdraw each year from your savings. Suppose for this example that you would need $100,000 per year, including a provision for taxes.
Step 3 – Estimate your required nest egg: As a starting point, for simplicity, you can use the “4% rule” to determine how big a portfolio would be required to safely provide this $100,000 per year. If you divide $100,000 by 4%, that would translate to $2.5 million. That’s the nest egg you would want to have accumulated by the first day of retirement. (I should note that the 4% rule is hardly gospel, but it provides a useful ballpark figure.)
Step 4 – Tally up the savings you already have accumulated: If you’re mid-career, let’s assume you have $300,000 saved.
Step 5 – Calculate how much you’ll need to save each year: Enter the above numbers into a spreadsheet using this formula:
= PMT(5%, 25, -300000, 2500000)
If you plug that into Excel or Google Sheets, the answer you’ll get will be about $31,000. That’s the amount you would need to reach your retirement goal with the above assumptions.
Step 6 – Stress test your results: You’ll notice that each number I’ve used here was an estimate. They might be reasonable, but nonetheless they’re estimates. For that reason, I recommend conducting stress tests. Try out a higher spending number, for example, or lower estimated investment returns. This is useful for two reasons: First, you’ll get a sense of the relative importance of each variable. As you experiment, you’ll see that some matter much more than others. Second, while I recommend boiling your goal down to a single number for planning purposes, it is important to first consider a range. For example, you might find that your plan will probably work with a savings rate of $30,000 but it will almost certainly work with savings of $40,000. Whether you choose to plan on the lower or the upper end of that range will depend on what’s feasible in your budget today and on your willingness to take risk. But it’s important to start by knowing where those lower and upper bounds are.
To be sure, there are other considerations that go into financial planning. But as a framework for managing your financial life today to help you get where you want to go tomorrow, I can’t think of a more useful way than the John Cleese way.