How much you need to invest

Most people invest whatever seems affordable and hope it is enough, which is a plan without a target and therefore without a way of knowing.

Working backwards

The structure of the calculation.

Decide what the money is for and when it is needed.

Estimate the amount required, in today's money.

Estimate a real return — after inflation and after costs — which should be conservative.

Calculate the contribution required to reach the target over the period.

Compare with what you are contributing.

Retirement calculators published by regulators and pension bodies do this in minutes and are free, and the result is generally uncomfortable, which is the point.

The retirement version

Where most of the money goes.

Estimate the annual income needed in retirement, which is frequently expressed as a proportion of pre-retirement income — commonly around two-thirds is used in planning, with wide variation depending on housing costs and lifestyle.

Subtract expected state provision and any guaranteed pension.

The remainder must come from savings.

Converting an income requirement into a capital requirement depends on the withdrawal rate assumed, which is contested — figures in the region of three to four per cent of the initial balance, increased with inflation, are commonly discussed, with a great deal of debate about their reliability across different return environments.

Which produces a capital target that is larger than most people expect.

The assumptions that matter

And that drive the answer.

Real return: the difference between assuming four per cent and seven per cent real is enormous over decades, and using an optimistic figure produces a comfortable answer and a shortfall.

Inflation, which should be handled by working in real terms.

Costs, which reduce the return and are frequently omitted from calculators.

Time, which is the most powerful variable.

Longevity, where planning to an average life expectancy leaves a substantial probability of outliving the money.

And contribution increases, since a fixed contribution over decades is unrealistic in either direction.

What to do with an uncomfortable answer

The levers, in order of effectiveness.

Increase contributions, which is the most direct and the most within your control.

Extend the timeframe, which for retirement means working longer and which has a disproportionate effect since it adds contributing years and removes drawing years simultaneously.

Reduce the target, which means adjusting expectations.

Reduce costs, which improves the net return without any additional risk.

Take more investment risk, which is the lever people reach for first and the one that may not deliver.

And increase income, which is outside the scope of a portfolio and is frequently the largest available change.

The contribution rate

Rather than the amount.

Expressing contributions as a percentage of income means they rise automatically with earnings, which is what prevents lifestyle absorbing every increase.

Automatic enrolment minimums in several countries are widely considered inadequate for a comfortable retirement.

Rules of thumb exist — one suggests contributing a percentage equal to half your age when you start — which produce uncomfortable numbers for late starters and reflect the arithmetic honestly.

And the single most effective habit is directing a defined share of every pay rise to contributions before it is spent.

Reviewing it

Annually rather than never.

Update the projection with actual balances and current circumstances.

Adjust for changes in income, household and objectives.

Check whether the assumed return is still reasonable.

Check charges, which change.

And check the state provision position, including any contribution gaps that could be filled.

An annual half-hour keeps the plan connected to reality.

Shorter-term targets

The same method.

A house deposit, a vehicle, a sabbatical, education costs.

The difference is the timeframe, which determines whether the money should be invested at all — under about five years it generally belongs in cash.

Which means these targets are savings calculations with a known rate rather than investment projections with an uncertain one, and are correspondingly easier.

The honest limitations

Worth stating.

Any projection over decades has enormous uncertainty, and the single number produced is the midpoint of a very wide distribution.

Which means a plan should be robust to a range of outcomes rather than optimised for one.

Building in margin, reviewing regularly and retaining flexibility about the timing and the target are the practical responses.

And a plan that requires an optimistic return to succeed is a plan with a high probability of disappointment.

General information only, not investment advice. Investments can fall in value and projections are not guarantees. Consult a regulated financial adviser.