A new kind of Bucket List …

This guy makes a big deal of this ‘new approach’ to investing.

Recognizing that people are scared of the market right now [AJC: before they become irrationally exuberant, again, in the next upswing] instead of giving this guy 100% of your money to invest in crappy mutual funds …

… you only give him 80%

You put ‘the other 20%’ into The Bank, so that you have 2 years of cash to live off, and essentially ride the downswings.

I think that they’re hoping that by focusing on that yummy cash, you’ll forget to check what the market is doing, until you next go to top up your 2 year bucket.

OK, pre-retirement, 2 years living expenses is way too much to have aside. $0 is a better number.

Post retirement, I agree on the 2 year number (in fact, I recommend it); but, I don’t agree with his recommendations for the 80% bucket

How to save $1 million by 65? Who cares?!

The current state of American financial thinking is terrible, if this is the best advice that “a senior editor with Money Magazine” can come up with:

Question: I’m 28 and would like to have $1 million by the time I retire at 65. What are some of the investing options I should consider? –Joshua Sin, Fresno, Calif.

Answer: I’m all for savvy investing, and I’ll get to what I think you should do on that front in a minute. But let’s not forget that when it comes to building wealth, investing alone won’t do it. –Walter Updegrave, Senior Editor, Money Magazine.

Walter Updegrave, the author, then goes on to provide a very interesting analysis of how to come up with the $1 mill by 65 – basically saying that it can’t be done:

If you begin putting away $100 a month starting now and continue doing so until 2047, the year you’ll turn 65, you would need an annual return of roughly 13.5% a year to turn that monthly hundred dollars into a million bucks.

What investment options can deliver a 13.5% annual return for almost 40 years? None that I know of.

True. Correct. Perhaps, Insightful.

But, I’ve said it before and I’ll say it again: who in their right mind cares?

Hasn’t Walt forgotten to ask the key question … why???!!!

Joshua is to be commended for thinking so far ahead, at the age of 28, towards retirement. But, shouldn’t our financial expert’s first step be to examine if the objective is reasonable?

Let’s give it a shot:

Choosing a much more reasonable go-forward inflation rate of 3.5% …

[AJC: The author assumed "a modest 2.5% inflation rate"; that's just UNDER the current outlook for the next 5 years, pulling out of a major global recession ... but, I wouldn't bet FOR a 40 year recession, if I were planning my own retirement!]

… by the time Joshua turns 65 that $1 million will only be worth $268k.

What does that mean?

It depends on what Joshua does with the money; however, given that his 37 year financial strategy has been simply to ‘save’ (presumably via CD’s, Bonds, Mutual Funds, and the like), I guess we need to assume that he will continue that strategy in retirement.

Therefore, Joshua will have little choice but to abide by the ‘advice’ of the financial planning community, which will be centered around finding a ‘safe withdrawal rate’; a great way to find out what that might be for Joshua, is to plug his $268,000 nest-egg into the T. Rowe Price Retirement Calculator:

Now, what annual income would be reasonable for somebody like Josh to aim for in retirement? $150k a year? $75k a year?

Let’s just say that he aims for $30,000 a year or $2,500 (before tax!) per month in today’s dollars; how well does he do with his $1,000,000?

Not very:

[AJC: PLUS whatever social security there may happen to be in 37 years time ... how optimistic are you?!]

Do you think that Josh would have been more surprised to learn that:

a) he would need to average 13% p.a. on his savings to reach $1 mill, or

b) even if he made it all the way to his $1 mill. target, he would only have $871 per month to spend?!

Our readers represent a small but keen-to-learn cross-section of people interested in the subject of personal finance;  let’s tell the financial services, advice, and publishing industries:

What sort of financial advice are you looking for?

Go ahead, leave a comment – especially if you’ve never done so before – and, we’ll challenge them to respond!

To mini-retire or not to mini-retire?

DrDollaz takes issue with whole ‘eat hamburger now so that you can eat steak later’ philosophy:

Problem with that philosophy is that years later – after being used to eating nothing but hamburger – most people have a hard time splurging on steak!

The whole fallacy of ‘saving so that you can enjoy retirement’ is BS – your life should be filled with mini-retirements.

But, Think Simple Now tried a mini-retirement and found that it wasn’t all it was cracked up to be:

When I first learned of the mini-retirement concept, I was immediately attracted to the idea. To me it represented freedom. I had all these romantic notions associated with it, and when I found a way to take three months off from work, I jumped at the first chance and ran with it.

While traveling is an eye-opening experience and a chance to see how others live in vastly different cultures. It is exhausting, on many levels. It quickly became clear to me that the romantic concept of traveling is flawed.

It turns out that TSN is more disillusioned with travel rather than mini-retirements, per se.

Fortunately, I agree with DrDollaz …

The $7million7years Way  is all about leading you to some future date where you have amassed the required amount of money to start living (your Life’s Purpose).

But, of course, if that’s all you take away then you’ve missed half the story:

Because I also say that money has only one purpose: to spend.

And, I have written many posts telling you to save now, but also to spend now!

Life is a journey …

… and, that includes the bits both before and after your reach your Number

The Golden Faucet

Ordinary folk don’t plan their finances during their working life, so what chance do they have in retirement?

None.

But, that doesn’t apply to us smart folk who read personal finance blogs …

… WE plan our retirement according to either Poor Man methods, or Rich Man methods known only to a few i.e. The Rich!

By the end of this post, you will know the difference; whether you choose to believe me and what you choose to do with this information is entirely up to you

So, here goes:

Conventional Personal Finance wisdom – clearly ascribed to by the majority of my readers – says that you pick a so-called ‘Safe Withdrawal Rate’ …

…. that is, the percentage of your retirement Nest Egg that you can withdraw to live off each year that you feel will be small enough that your money will last as long as you do.

A sensible objective, wouldn’t you think?

You can pick any % between 2% and 7% (even up to 10%, if you believe all of those Get Rich Quick books) and find some expert or study that supports your choice.

You then have a choice to

a) make that % a fixed amount of your initial retirement portfolio (e.g. let’s say that you retire with $1,000,000 and choose 4%, giving you an initial retirement salary of $40k p.a.), then increase that salary by c.p.i each year regardless of how your portfolio rises or falls [AJC: it's called the "close your eyes and hang on tight" approach to retirement living], or

b) choose your preferred ‘safe’ withdrawal % and let that rise and fall according to the rise and fall of your your portfolio’s value … so, if you happen to retire a year before the next stock market crash, you could be withdrawing 4% of $1 mill. in one year, then 4% of $500k the next year [AJC: no problem, as long as you can stifle the urge to jump off a ledge when your income halves, as well]

Optimists will choose a withdrawal rate in the 5% to 7% range and pessimists will choose a withdrawal rate in the 3% to 5% range …

… Rich people will do neither!

Why?

Well, before you retire (i.e. now, while you are still working) you could draw a curve of your likely salary moves between now and retirement and you could pick a living standard that corresponds to that curve, using actuarial tables to basically create an inflation indexed annuity for yourself throughout your working life.

But you don’t.

Instead, you live according to your means – and, adjust as necessary – and, build up various safety nets (via cash reserves and insurances) as you deem prudent and necessary.

Why would you do any different after you retire?

Poor people who retire put their money in a bucket and a little trickles in (interest, dividends, capital appreciation) and a lot gushes out (inflation, taxes, expenses, disasters).

You have a bad year or three, overspend a little, a couple of health issues, and you’re screwed [AJC: it even happens to retired sports stars, movie stars, and musicians. Ever heard of MC Hammer?].

But it doesn’t happen to smart Rich people, because they don’t drink from a bucket … they drink from a golden faucet:

They create – then live from – an income, both before retirement and after!

Think about our energy crisis past, present and future … all resolvable (we hope!) by switching to an abundant source of clean, green, renewable energy.

Now, think about all of your spending crisis past, present and future … all resolvable (you hope!) by living within your means a.k.a. creating an abundant source of renewable income!

That income can come from a family business that you retire from but retain “passive” part-ownership of; from venture capital activities; from real-estate investments; and, so on … in fact, from any investment that produces a reliable income stream that tends to grow at least in line with inflation.

Here is how I planned it:

1. I used the Rule of 20 strictly for planning purposes [AJC: this sounds like a 5% withdrawal rate, but who said that I'm actually going to withdraw the 5% each year?!]

2. I started creating a Perpetual Money Machine: something that will produce income that I can live off; in my case, it was RE bought with (or, for which I already have built up) plenty of equity or cash to ensure a healthy positive cash flow.

3. To cover ‘bad years’ and other contingencies, I retain at least 25% of the income stream until I have built up enough for TWO YEARS of living expenses and then I reinvest whatever is left over (i.e. buy another property every few years).

So, what if something goes wrong as it did for me when the GFC hit leaving me with too much house, another house I can’t get rid of, and $2.5 million of unavoidable stock losses [AJC: part payment for my business came in UK stock ... yuk!], resulting in not enough income?

You go back to MM201 and start again (hence, my commercial property development activities) …

… after all, history has shown that your first fortune is by far the hardest

The Ultimate Gift – Part II

If Monday’s post didn’t spur you to start early, this one sure should!

First, here is something that will upset you if you are already 55 and figure that you need another 10 years to retirement:

Not bothered?

Well, let’s see if we make the same comparison, starting with a much earlier retirement age:

If you used to think that a lifetime of work was good for you, think again - this chart [AJC: the blue line is the important one] shows:

The longer you work, the shorter you live!

From another article:

Generally, it is found that people retiring early live more, but how long do they live? Or what is the average number of years they live after retirement? Well, now 49-50 is usually not considered to be a retirement age in most countries. However, if a person plans everything well and retires at the age of 50, he is expected to live for at least another 35-36 years, which increases the life span to almost 85-86 years! People retiring in their early 50s, normally live up to their late 70s or early 80s and people retiring at their early 60s, live till their early or mid 70s.

We had a pretty important reason to aim to Get Rich(er) Quick(er) i.e. so that we could have the time and money to finally live our Life’s Purpose …

…. but, if you don’t have a clearly defined purpose, then let me give you just one real clear, real simple reason to get Rich(er) Quick(er):

If you retire before 50, you will live 20 years longer than if you wait for normal retirement age.

No longer is the idea that ”business/investing is too stressful … I’ll just wait it out in my nice stress-free post office job” valid …

…. I don’t care whether you intend to retire with $1 million or $10 million, as long as you reach your Number much sooner than you otherwise would.

By reaching my Number at age 49, I not only gave myself the gift of finally having the means to truly live my Life’s Purpose, but I also gave myself the gift of 20 years extra in which to live it …

… this, too, is my gift to you.

Don’t waste it!

Fitting a square peg into a round hole …

The real problem with any of the so-called ‘safe withrawal rates’ that we explored yesterday – with 4% currently being perhaps the most popular amount advocated - is that they all assume a fixed annual spending amount, but are actually generated by a totally volatile (some would say random) portfolio.

We’re trying to fit a square peg (fixed annual spending) into a round hole ( a ‘random walk down Wall Street’)

But 7m7y readers have an even more fundamental problem with planning our ‘retirement’ based on this type of common industry wisdom: we are planning on retiring early, hopefully, with a very large Number and a soon Date!

Most retirement models assume a 30 to 35 year retirement lifespan …

… I don’t know about you, but I retired at 49 and intend to live AT LEAST another 40 years

Many of my readers will be aiming to reach their Numbers even sooner .. and, may expect to live even longer!

The bottom-line: traditional retirement planning models don’t work, because we need money that will last as long as we do … we need a Perpetual Money Machine, because we don’t know how long we will live once we stop working.

A Perpetual Money Machine is anything that:

a) Protects your capital over the long-run, even allowing for the ravages of market changes and inflation, and

b) Produces a reasonably reliable stream of income, that also (at least) keeps pace with inflation.

Neither stocks nor bonds – the traditional tools of retirement investing – fit the bill for us:

1. Stocks are too volatile, and the income tends to be artificial (e.g. so-called dividend stocks attempt to fix the level of dividend provided even as the company’s profits fluctuate).

[AJC: Raiding marketing, R&D, and other seemingly non-essential budgets in lean years in order to protect the dividend stream is - to my mind - the mark of a poorly run company]

2. Bonds provide a very safe return, but the % returned each year is too low, meaning – at least, to me – an unnecessarily reduced lifestyle, especially after allowing for reinvestment to try and keep up with inflation.

That’s why my Rule of 20 is exactly that: a planning rule, NOT a 5% spending rule!

[AJC: Otherwise, I would have called it the 5% Rule, d'oh!].

In other words, my advice for PLANNING your Number, is to decide what initial income you want and multiply that by 20 in order to find your Number …

… but, my advice for LIVING your Number is to turn on your Perpetual Money Machine and live off whatever it happens to produce, after allowing for taxes and provisions against inflation and contingencies.

The Myth of the Safe Withdrawal Rate …

I have noticed an unusual phenonemom: I write a post on one theme and your (i.e. our readers’) comments explore another one entirely!

This is a GOOD thing … it means – I hope – that we are building an online community dedicated to the idea of linking our finances to our life, rather than simply attempting to fit within society financial ‘norms’.

Case in point: I wrote a post exploring various windfalls, and the comments lead us down the path of exploring so-called ‘safe withrawal rates’, which is the idea that there is a Magic Percentage of your Number that is ‘safe’ to withdraw to live off each year.

The problem is, what % do you choose?

For example, I have proposed the ‘Rule of 20′ for calculating your Number, which seems the same as proposing a 5% ‘safe withdrawal rate’, but Jake disagrees:

A 5% drawn-down rate on the pot of gold is a little on the risky side if you want the money to last.

After looking at a bunch of data, I feel that a draw-down rate of 2-3% is too conservative, but 5-6% to aggressive. 4% or so seems right. I know, only 1% off from your value but over time it makes a huge difference.

So, Jake has highlighted one problem with selecting a ‘safe’ withdrawal rate … if you are out by even 1% your spending can be over (or under) the ideal by 20%. I don’t know about you, but a 20% payrise (or paycut) is a pretty big deal … people quit their jobs over less!

So, what do the experts recommend?

Believe it or not, there is support out there for just about any annual % of your nest egg that you may choose to spend, for example:

7% – Not so long ago, the financial services industry proposed spending as much as 7% of your portfolio each year in retirement.

6% – More recently, Paul Graangard wrote two books proposing a bond-laddering and stocks strategy that supported a spending rate as high as 6.6% of your portfolio each year.

5% – Investment funds routinely allow spending of 5% of the portion of their investment portfolios dedicated to simply keeping up with inflation. Indeed, my Rule of 20 appears to support this withdrawal rate, too.

4% – A large number of studies – probably, the most famous of which is the so-called Trinity Study - advocate spending up to 4% of your initial portfolio (ideally, 50% stocks and 50% bonds, rebalanced each year), which provides somewhere between a 90% and 100% certainty that your money will last at least 35 years.

3% –  A whole slew of new retirement planning tools (generally using a Monte Carlo approach to modelling tens, hundreds, or even thousands of potential economic scenarios) have been released over the last 4 or 5 years by the financial services industry, purporting to analyse hundreds of alternative economic scenarios to try and model what would happen to your retirement portfolio (i.e. simulating changes in interest rates, market booms and busts, etc.) to find the ideal ’safe’ withdrawal rate. The trouble is that a lot of these advocate very low withdrawal rates, typically in the 2.5% – 3.5% range. 

2% – Some even advocate a totally ‘risk-free’ approach to retirement savings by investing close to 100% of your retirement portfolio in inflation-protected bonds (i.e. TIPS); historically, these have provided a 2% return, after inflation and with total protection of your starting capital.

So, which is right?

None, as TraineeInvestor explains in his comment to my post:

I’m not fan of draw down models either. If you have to spend your capital to avoid eating cat food (or the cat) or are working with a very limited time period fair enough. But with a sufficiently long time horizon, my view is that any draw down rate is dangerous – in fact I would be uncomofortable if my nest egg was not growing at at least the rate of inflation (after taxes and spending).

Another way of looking at it is that if you are relying on draw down of capital for living expenses you are very vulnerable to adverse events. No thanks – I’d rather sleep soundly at night.

Me too!

You’re poorer than you think …

This very funny video is a great argument for NOT having life insurance …

… you never want to be worth more dead than alive

In fact, I canceled my policies, but not until I already had my $7 million sitting in the bank.

How about you?

Retiring with enough …

Philip Brewer has written a couple of articles for Wise Bread exploring the question: “Can You Buy Your Way Out of the Rat Race?”.

He says:

If you’re tracking your spending, you know how much money it takes to live on. If you’re tracking your investments, you know about how much return you’re getting from your capital. With those two numbers, you can get a pretty good estimate of how much money it takes to buy your way out of the rat race.

In its simplest form, the cost to buy your way out is just your annual spending divided by the return on your investments. I used to do that calculation a lot. When I got my first job interest rates were in double digits, so I could imagine getting $30,000 or even $40,000 a year — plenty of money to live on — from an investment as small as $300,000.

This is good advice if you want to retire on “$30,000 or even $40,000 a year” … I don’t

The problem with these types of retirement articles is that they usually start from the assumption that your current salary +/- 30% is what you want to live off.

When my salary was $250k, this probably also held true for me … but, just a year or two earlier (when I was actually planning my own retirement) my salary was only $50k – plus my wife’s $60k, making our total household income less than half my ‘required retirement salary’.

So, I describe the retirement calculation process much as Philip describes it, with an extra step:

1. Decide what you want to do with your Life

2. Decide how much annual income you require (probably, without needing to work … but, that’s up to you)

3. Convert that amount to the capital that you need.

Now, Philip would say that you should subtract any income and/or pensions that you expect to receive along the way …

… I recommend that you don’t.

You see, you may not want to – or be able to – continue work through your ‘retirement’ – and, government pensions can always be taken away.

Rather, I recommend that you assume neither of these while you are ‘retired’, and reinvest any such ‘windfall income until you have enough accumulated to effectively increase your Number, hence your standard of living.

Huh?!

Well, Philip suggests:

Among people who invest for large institutions, there’s a rule of thumb that you can spend 5% of your endowment each year, and then expect to have a bit more to spend next year than you spent this year.

Of course, they can’t expect that 5% to be more every single year. Some years the investment portfolio does poorly–and after one of those years, the 5% that’s available for spending will be less than the previous year. Maybe much less.

For households, therefore, the rule of thumb is 4%.

We have a similar rule: The Rule of 20, which seems effectively the same as Phil’s 5% Rule [AJC: we'll explain why it's actually a VERY different concept, in a series of MM301 posts, coming up soon] … this is probably enough because you will probably:

- Earn some additional money in retirement (remember those part-time income and pensions that we mentioned?)

- Spend a little less as you get older (unless you feel that health care will outweigh all of those Learjet trips?)

- Overshoot your Number, if you wait until reaching your Number (on paper) before actually trying to sell your business / real-estate, etc.

BUT, don’t let me stop you from building in an additional buffer by modifying my ‘rule’ to anywhere between the Rule of 20 to the Rule of 40.

Hint: I wouldn’t bother … the Rule of 20 is plenty to aim for; but, don’t let me stop you from aiming for more …

…. just don’t try and make it LESS

Are you saving enough for retirement?

This video asks an important question, one that we asked our readers some time ago (and, will answer tomorrow).

It also seems to indicate that roughly 8% is a safe withdrawal rate, at least for men who choose to retire at the standard retirement age in the USA … we’ll explore this further, through a series of posts beginning later on this week.

For now, what do you think is a ‘safe’ % of your Number to live off each year?