As financial advisers, a huge part of our job is answering money questions. Out of all the questions we are asked, there is one which comes up with almost every client.

How much do I need for retirement?

The Herald released this article the other day. Taking figures from an annual Massey report on retirement spending, they believe $809,000 in savings is needed by a city-dwelling couple. From an initial lump sum of $809,000, they believe this couple could spend about $1,500 per week throughout retirement.

As a rule of thumb, $800,000 seems like a good target for the average Auckland-based couple. But nobody truly fits the average.

How much do New Zealander's need for their retirements? I'm happy to use the Massey figures for that. How much do you need for your retirement? That takes a little more work to figure out.

Starting with spending

There are many factors which influence how much you need. Of course, the best place to start is figuring out how much you expect to spend. And to estimate how much you expect to spend, you should understand how much you spend now.

When we help clients plan for their retirements, we start with their current outgoings. Ideally, you could leave your last day of work without your spending changing at all. Instead of the money coming in from working, it comes from retirement savings.

Sure, some things in your budget will change. You may no longer be driving into the office each morning or maybe you will spend more time eating out. But for a ballpark figure, what you spent previously is a good estimate. If you have some extravagant plans, add it on top.

Retirement is long

You may spend a similar amount of time in retirement as you do in your working years. It can be daunting to plan for such a long period without regular income.

During retirement, you can still have flexibility to change plans as needed. Part of the benefit of planning now is you can see where your plans can be flexible.

Many people choose to live it up early, with lots of travel and big purchases. Others prefer to ease into it, without making any big changes at all. Consider what sounds most appealing to you.

We typically plan for spending up until the age of 90. Ideally you are confident your savings will last until this point. You may want to choose a different timeframe over which to plan your retirement. Keep in mind, downsizing is a popular and effective method to raise capital once your retirement savings are all spent.

Another common concern is the cost of healthcare later in life. Typically people's spending does not change significantly as they reach this point as these costs are balanced by reduced spending elsewhere. When we get older, we tend to spend less on big trips and fancy cars.

If you wanted in-home care, it might be something to consider earlier. For most New Zealanders, rising healthcare costs are not as significant a concern as often thought.

Risk capacity and risk tolerance

If you understand how much you will spend and for how long, you may be getting an idea of how much you need before retiring. But, for the majority of retirees, their savings shouldn't be in cash. Investing these funds helps provide the extra returns needed to outpace inflation and provide for your needs late in retirement.

When deciding how to invest your retirement savings, it is important to understand both your risk capacity and your risk tolerance. In short, risk capacity is how much risk you can or should take, risk tolerance is how much risk you feel comfortable with.

Risk capacity describes how much risk is appropriate for your financial goals and position. For example, a young, working person has a high risk capacity, as their savings are not needed for a long time. They can afford to take risks. For someone drawing upon their savings, their risk capacity is lower, as investment losses may severely affect their ability to continue their withdrawals.

Exceeding your risk capacity means risking your ability to reach your goals if your investments perform poorly. Undershooting your risk capacity means not achieving the returns needed to fund your goals.

Risk tolerance describes how much risk you are comfortable taking on. Typically your tolerance is measured using a questionnaire and assigning a score out of 100. A person with a low score is risk averse and may be uncomfortable with market downturns, uncertainty in returns or investments they don't fully understand. A person with a high score is comfortable with the ups and downs of investment markets.

Investors rarely invest below the limits of their risk tolerances, unless it has been understated or their goals require them to take less risk. More concerning is when investors invest above their limits. The most common reason investors perform worse than the market as a whole is due to selling when share prices fall. Also, those who take on more risk than they can handle have a poor investment experience, with much anxiety  when performance is not great.

Understanding both your risk tolerance and your risk capacity will help you decide what type of portfolio is right for you.

How much is enough?

Once we know how much you want to spend and for how long, we can state this as your retirement goal. Knowing your risk capacity and risk tolerance shows which portfolio is appropriate for you. The last step is to estimate how much you need saved up to last the whole nine yards.

Instead of simple estimate of returns and withdrawals, we use Monte Carlo analysis for this last step. Monte Carlo is a statistical process which helps us estimate how your portfolio will perform in different scenarios. It accounts for periods where performance is strong and periods where it is weak in order to give a probability your portfolio survives. With a high probability of success, we deem the initial portfolio value enough for retirement.

As the years go by, we are able to track each client's progress against these projections. When needed, adjustments can be made to keep everything on track.

For a rough estimate, you may choose to simply add the return you expect each year, subtract the expected withdrawals and adjust for inflation. If you want help with a more sophisticated plan and strategy, we recommend speaking with a financial adviser.