Flipping the Most Common Question in Retirement Planning On Its Head
The most common question I see in retirement planning is: What size nest egg do you need to quit working? Or, what’s your retirement “number?”
It sounds like a reasonable and straightforward question.
The problem is, it’s completely useless.
Like so many things in the financial planning business, the question takes something complex and full of nuance, and effectively dumbs it down to the point where it doesn’t mean anything. And that’s because it misses the bitter truth about retirement: you never know how much you’re going to need.
Some say that to retire successfully you should multiply your final salary by a factor of 10. So, if in your late 60s you expect to be earning $150,000, you’d need $1.5 million to retire.
But does that actually work?
The rule of thumb for a “safe” withdrawal is the “4% Rule.” If you limit your withdrawals to just 4% of your portfolio per year, you have very little risk of depleting your funds and running out of money in retirement.
Well, using the 4% Rule would give you an annual income of $60,000, which might be just fine for you.
Or it might not.
What if you need more than $60,000 to pay your bills? What if the stock market has a major setback early in your retirement and your $1.5 million gets chopped down to $750,000 or less?
You might roll your eyes now, but that’s exactly what happened to millions of people that retired or were planning to retire during the last two bear markets.
This is no way to plan for your golden years. It’s income that pays your bills, not the size of your bank account balance. Focusing on an asset number rather than an income stream is like putting the cart before the horse.
In a raging bull market, this would matter a lot less. In that scenario you could reliably sell off assets along the way to meet your income needs. But in today’s market, that’s a risky proposition. The market is stretched after eight years of nearly uninterrupted bull market, and I’m a lot less comfortable depending on capital gains that might disappear tomorrow.
This is what I recommend you do…
Step #1: Grab a piece of paper. Write down a yearly income number you think you can live on in retirement. Try to be honest and reasonable and let your current monthly expenses be your guide.
Now, once you have that number… add 20% to it. You know as well as I do that expenses always seem to find a way of turning out to be more than you expected.
Step #2: OK, now that you have your “real” income number, start subtracting any “guaranteed” income sources. This includes things like Social Security or any pensions you have.
So, let’s say you need $100,000 to live every year (after adding in your 20% cushion). And let’s assume you expect to get $40,000 per year from Social Security, and another $20,000 from a private pension.
That just leaves you with $40,000 to come up with every year to meet your $100,000 goal. And that’s Step #3.
Of course, with bond yields scraping along at today’s lows, securing a safe $40,000 (or whatever the figure is for you) may seem easier said than done. But it’s really not difficult if you know where to look.
Some people prefer annuities. I’m really not their biggest fan as a savings vehicle, but I see their value as distribution vehicles. With an immediate annuity, you give a block of cash to an insurance company, and they, in turn promise you a guaranteed monthly income for the rest of your life, essentially a one-man pension plan.
The only problem I see with annuities these days is that, with bond yields as low as they are, annuity payouts are a lot lower than they used to be. So if you’re needing a higher yield and seek automatic income, I’ve got just the thing for you.
You might want to consider one of the private income funds that I’m going to talk to you more about very soon. Watch this space for more info. Used the right way, they’ll help you close that income gap with consistent checks arriving monthly.
Then, once you have your income needs met, have fun with whatever’s left in your portfolio.
In other words, take a little risk, or try an active trading strategy. You can use any trading profits for little luxuries like travel, or to buy gifts for the kids and grandkids. And doesn’t that sound nice?
Editor, Peak Investor
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