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How Big Should Your Retirement Nest
Egg Be?
Simple Math Gives
You An Idea.
.
Like many of my
clients, you may never want to stop doing what you do. At some point, you may
just want to do it part time. Personally I cannot imagine ever not trading
stocks. My son Ross, age 11, told me last night that I could always just trade
if I wanted to stop working.
There is a big
difference between having to work and wanting to work. If you have to work then
you are burdened with the ball and chain of obligation. You can't just walk at
any moment and that creates attachment and resentment.
When it comes to the
game of money detachment is ideal. Let's say you are 60 years old and are
working because you enjoy it and not for the money, you can be detached from
your work. Your perspective changes and you can then create better results for
you and the people you work with.
 So
how can we get detached from the economics of our work? My solution is
simple. Build a big bucket of investments that make money in all market
environments. The size of the bucket depends on how long it needs to last and
how much you need to take from it to support your lifestyle. So let's figure out
how much you need to live on and how long you plan to live so we can determine
the size of the bucket you need.
Let's start with
how much you need to live on in retirement. I will assume that you want to
maintain your lifestyle and that you will spend less on work related items but
more on travel and entertainment. For example purposes let's say you would like
to live on $10,000 per month or $120,000 annually. This example will allow you
to adjust the numbers easily. If you spend $5,000 monthly then cut the number in
half.
The source of your
income to cover your $10,000 monthly nut will be your portfolio of investments.
If you are working part-time you can reduce the income you need to withdraw by
the after-tax income from your work.
If you are healthy and
will have a long retirement of 30 + years, you should not withdraw more than 4%
of your money annually. If you are retiring later, say at age 70, then you might
raise the number to 5%. At 70, your life expectancy is about 20 years so you
need less money.
Another easy way to
look at this is to take the amount you want live on and multiply it by 25 for a
4% withdrawal or 20 for a 5% withdrawal.
| Living
Expenses |
4%
Withdrawal |
5%
Withdrawal |
| $120,000 |
$3 million |
$2.4 million |
| $100,000 |
$2.5 million |
$2 million |
| $80,000 |
$2 million |
$1.6 million |
If you require
$120,000 annually and plan to work part-time making $60,000 until you are 70
then you will require a smaller portfolio of say $2.4 million.
So how do you get
your portfolio this big by the time you decide to retire? First take a look
at the assets that you have now that you will be selling prior to retirement.
What about the value of your business? How about the value of any commercial
real estate? If you decide to downsize your home, you may have some equity that
you can contribute to your portfolio.
Be conservative
about the value you place on these alternative assets. Remember that all
asset prices are a function of supply and demand. Also remember that supply and
demand is driven by human emotion. That is why renting a home in some areas of
the country is less expensive than buying a home. The timing of your sale of
these assets will be critical to achieving the ideal price for them. Since
timing the sale of these assets can be difficult you should be conservative in
your estimates of their future values.
 Let's
say you want to retire at age 60 and require a $3,000,000 portfolio to maintain
your lifestyle. If you sell a business and keep $400,000 after taxes and
downsize your house and retain $500,000, you have reduced your saving
requirements to $2.1 million.
If you operated your
business out of your own building and then sold that building, you may have
another $750,000 to contribute to the portfolio. Maybe you should call me about
how to own your building! Outside of the sale of these assets you will need
$1,350,000 in a portfolio.
Taxes and inflation
eat away at the value of your portfolio. Per Ibbotson, the after tax and
after inflation return, called the real return, for stocks from 1925 until 2004
was 4.8%. If you earn this on your investments annually and spend less than what
you are earning, you will never run out of money. You can find periods where the
market has done much better than 4.8% real and much worse. Also, the way
Ibbotson calculates taxes may be materially different for you and will impact
your results.
Bottom line: If I
were you, I would have a professional money manager running your money. Maybe
you should call me about this too?
For those of you that
don't want to expire with a large portfolio, you can start spending more prior
to dying. This assumes you know when you will die. Since the market can
fluctuate wildly and you can hit periods with year over year declines in value,
you should not try to consume more than 5% of your portfolio annually.
 Do
not wait to begin funding your portfolio. You can reach your goals much
sooner if you start sooner. Waiting 5 years will cost you $1 million assuming a
20 year time horizon. Send me an email if you want the proof.
There are strategies
that you can take to fund your investment portfolio, the details of which I will
leave to other articles. If you need help crafting your specific approach give
me a call and we can talk. Most people, especially business owners, have ways to
fund their portfolio and don't optimize the opportunity.
Note: Since eligible
social security benefits vary by person and the timing of those payments vary
based on your birth date I have left them out of this article. You can look at
your annual statement from the Social Security Administration to determine your
future benefits.
Have
a question or a comment for me?
Send
it to david@financegeeks.com.
Finance Geeks
provide unique wisdom and expert advice to healthcare professionals. Their
strategies help dentists create and maintain wealth. David Catalano has over 20
years experience dealing with dentists.
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