Transitioning to retirement …

withdrawal1You’re hard at work, trying to to reach Your Number, and you’ve cranked up your Perpetual Money Machine to make sure that you get there …

… now, there’s not much to do except work the plan.

So, let’s fast-forward a few years and think about what happens when you finally reach Your Number.

If you recall, you calculated your Number simply by:

Taking your Required Annual Living Expenses (which you adjusted for inflation) x 20.

Now, where did this Rule of 20 come from?

It is simply the same as withdrawing 5% from your Number each year.

Picture your Number as a pile of cash that you made by saving, investing, or even selling your real-estate and/or business portfolio, and now it is sitting safely in the bank as cash or CD’s, earning bank interest each year. The question is, how much can you safely withdraw each year to live off (like paying yourself a wage) so that you never run out of money?

When you are busy ‘working’ (be that on a job, in a business, or on your actively-managed investment portfolio) you will dream of nothing but having that pile of cash that equals Your Number just sitting there.

But, when you have that pile – hopefully, very large pile – of cash you will suddenly realize:

1. You have to pay taxes on the interest,

2. You have to beat inflation,

3. You have to spend some of your capital to live,

4. You have to survive market downturns.

You have to hope this money lasts as long as you do!

… all of a sudden, you have to be VERY protective of Your Number.

When you are working, you fear losing your job. When you start to invest, you fear losing some or all of your investments. When you start or buy a business, you fear closing down. The reality is that you can recover from any/all of these scenarios given a little extra time and work. But, if you lose Your Number, you have lost everything … and, the longer it takes to lose it, the less time/chance you have of recovering it.

So, a key question becomes: what is a SAFE percentage of Your Number to withdraw each year? Usually, a great place to start is by looking at what ‘the experts’ recommend …

Unfortunately, there is support out there for just about any annual % of Your Number (i.e. your retirement 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 combined bond-laddering and stocks strategy that, he suggested, 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. 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 (e.g. US Government Inflation-Protected Bonds – TIPS; Municipal Inflation-Protected Bonds – iMUNIs); historically, these have provided less than 2% return, after inflation but with total protection of your starting capital.

So, which is right?



There is no middle ground …

To me, making $7 million in 7 years (or some other Large Number / Soon Date) is not the goal … at least, it was never the goal for me.

My goal was always to become financially free and have the ability to live my Life’s Purpose.

It just so happened that, when I crunched the numbers, I found out that I needed to make $5 million in 5 years.

[AJC: now, thanks to my book, this process has been highly simplified, if you want to do the same]

I failed on the time frame, but ended up with $7 million in 7 years and promptly retired, at the ripe old age of 49. Now, I blog here (amongst other enjoyable ‘give back’ things that I do).

Fortunately, the goal for some is a lot lower.

For example, in my last post I showed that – if you are happy living on just 50% of your current income for the rest of your life (after adjusting for inflation) – you just need to save 50% of your paycheck every week for the next 17 years.

If this is you, then you need to be reading blogs other than this; you need to save/save/save, max your 401k, pay off all of your debt, and stay very frugal. After all, living on half a paycheck is not easy 🙁

But, what about the rest of us?

Well, I asked you to spend some time with an online retirement calculator; if you took my advice, you probably found something like this:

This means that a couple earning a combined $50k a year today (with 20 years left until retirement), saving a full 10% of their income, has only a 50% chance of their money lasting as long as they do … even if they receive full Social Security benefits for the next 40+ years!

Without Social Security, this couple has virtually no chance at all (1%) of their money lasting as long as they do even if they save 15% of their paycheck for the next 20 years. If they manage to save 25% of their combined pay for 20 years, their chances of financial survival are still less than 25%.

How does creating an emergency fund, paying off all debt, and paying yourself first actually help these people financially survive after half a lifetime of work?

In the above context, I don’t think it helps much, at all.

Really, most traditional personal finance boils down to: saving 50% of your pay packet for the next 17 years, or taking your chances on Uncle Sam looking after you for the rest of your non-working life. The rest is fluff.

If that doesn’t appeal, stick around for the final part of this three part series, where I’ll share my strategies for real financial security.


Why cookie-cutter personal finance does not work

Marie (speaker, blogger, investor) agrees with my simple plan for wealth creation:

I have to go with your 2 step plan. All my years in PF it seem to work best than the cookie cutter approach.

The ‘cookie cutter’ approach that Marie refers to are the approaches that I was talking about in my provocatively titled guest post at Budgets Are $exy: “Why Most Personal Finance Blogs Are B.S.“, and includes: paying off all debt; maintaining an emergency fund; frugality and expense-cutting; paying yourself first via max’ing out your 401k; and, so on.

[AJC: To be fair, I was asked to write something ‘feisty’ so you should head on over and read the article (and the comments) now …]

To prove any personal finance strategy you need to have an objective against which you must measure the outcome.

To me, that goal must be: financial freedom.

But, what does ‘financial freedom’ mean?

That depends entirely on you …

If your goal is to simply replace your income, say, within 20 years, and you can train yourself – through frugality – to live on a lower income than your peers then it is possible to save your way to wealth (simply defined as financial freedom, or having enough passive income to replace your then-current income from employment).

For example, MB writes about her 12 year plan to replacing her and her husband’s dual working income:

After a couple years of full-time work I started to wonder, how can anyone possibly tolerate doing this for 40 whole years?!

[Now] our number is somewhere in the $1-2M range depending on how many kids we end up having (if any). But, then again, we are saving >50% of our salaries.

By ‘training’ themselves to live on only 50% of their salaries – or 1/4 to a 1/2 less than their peers – MB and her husband accomplish two purposes:

1. They save a lot more than most people,

2. They live on a lot less than most people

So … they need a much smaller Number than most people and they’ll be able to reach that number much, much sooner than most people.

According to my calculations, if you start off earning, say, a combined $50k p.a. and are prepared to live off just $25k of that (assuming your combined salaries increase by 3% per year, and you get a very hefty 8% after-tax return on your savings) you will be able to retire on a combined $40k passive income in not the 12 years that MB is hoping for, but a still-healthy 17 years time.

The catch is that just 4% inflation would mean that you really have the earning power of a little less than $25k p.a. today.

In other words, to actually make this cookie cutter personal finance plan work, you need to be debt-free and be able to live on just half your current annual income for your whole life.

Is this you?

If not, I recommend that you spend a little time with an online retirement savings calculator and work out what income you would need in today’s dollars (i.e. assume you retire today) …

… then, leave a comment and – in my next post – I’ll explain what that means and what you need to do to get there.



You can be a millionaire in your lifetime …

Australia’s (now the world’s) richest woman is worth $25b or so …

… and, she says that you can be a millionaire:

There is no monopoly on becoming a millionaire.

If you’re jealous of those with more money, don’t just sit there and complain. Do something to make more money yourself – spend less time drinking or smoking and socialising and more time working. Become one of those people who work hard, invest and build and at the same time create employment and opportunities for others.

Of course, Gina Rinehart inherited one of the world’s biggest iron ore deposits …

… you and I have to find our own lump of wealth 😉

But, I agree with her sentiment: increase your income (“spend … more time working”) and put your money to work for you (“invest and build”).

If you do, getting to a million will be a snap:

If you start off earning $25,000 and work for 40 years (earning around $80k in your last pre-retirement year), and save just 10% of your annual salary (earning 8% on your money), you will have exactly $1,000,000.

Of course, you will be used to living on $72k p.a. ($80k less 10% for savings) by then, and $1m will ‘safely’ give you only half of that to live off … oh, and you can halve that twice again to allow for inflation, so you will really be retiring on the equivalent of $10k a year, today.

But, that’s not the point; the point is that you can be a millionaire in your lifetime …

Of course, getting to $7 million in your lifetime (let alone in 7 years) still won’t be a piece of cake!

But, that’s where this blog comes in 🙂

A new kind of slum dog millionaire …

KC points me to an article in Yahoo Finance:

A new AP-CNBC poll finds nearly one-third (31 percent) of U.S. residents believe they would need a minimum savings of $100,000 to $500,000 if retiring this year in order to be confident of living comfortably in retirement, and 22 percent believe the minimum is $1 million or more to retire comfortably.

I’ve just conducted my own survey and I’ve found:

– Nearly one-third (31 percent) of U.S. residents are totally deluded if they think that they can retire on $100,000 to $500,000 today.

– 22% are only slightly less blinded to the obvious to think that even $1 million will be enough to sustain them in retirement.

Let’s say that you can withdraw 4% of your portfolio ‘safely’ each year (a figure commonly promoted by the financial planning industry): then, you can give yourself a salary of:

– $4,000 per year if you retire today on $100,000

– $20,000 per year if you retire today on $500,000

– a whopping $40,000 per year if you retire on $1 million

Now, there’s be a whole bunch of people reading this who’ll say: “$40k a year, indexed for inflation … for life … without working. Now I can live with that!”

So, let’s see what it will take to get to $1 million in retirement savings; the same article says:

If you start with an initial $10,000 investment and your portfolio grows by 5 percent every year, here’s how much you need to save each month to reach your $1 million goal by age 70, according to’s calculator.

• 25-year-olds have to save $450 a month. That’s just $15 a day for the rest of your working years.

• 35-year-olds have to save $850 a month.

• 45-year-olds have to save $1,700 a month.

• 55-year-olds have to save $4,000 a month. (Of course, with an average inflation rate of 3 percent, that $1,000,000 nest egg will only be worth $642,000 in today’s dollars. So that means you’ll likely wind up having to save even more.)

Did you check out that last point? Even if you could save these amounts, your $1 million is whittled down by inflation by the time you get there, so $40k expected retirement salary is only worth (in today’s dollars):

– $30,000 p.a., if you’re 55 and have 10 years to retirement

– $20,000 p.a., if you’re 45 and have 20 years to retirement

– $10,000 p.a. if you’re 35 and have 30 years to retirement

… or, to put it another way – because of inflation (even at only 3%), if you want to retire at age 65 on the equivalent of today’s $40,000 salary, you need to:

– Quadruple the above suggested monthly savings rates if you’re 25

– Double the above suggested monthly savings rates if you’re 45

– Add 50% to the above suggested monthly savings rates if you’re 55

… Oh, and did I mention that these numbers are after tax?

And, just when you were kidding yourself that you really can save yourself to a decent retirement: current CD rates are 1% and inflation is still running close to 0.5%, meaning that even a 4% withdrawal rate – previously described as ‘safe’ according to the financial planning industry – is committing financial suicide.

On current returns, to safely pay yourself $40,000 p.a. (indexed for just 0.5% inflation) you would need to retire with a nest egg of not just $1,000,000 …

… but, $8,000,000.

Or, you could just keep reading this blog and find a whole new way to look at your financial future 😉

[AJC: Try and find consensus on inflation; it’s hard! One article that I saw in researching this post suggested that inflation is currently running at just 0.5%, another says 4%, as suggested by Steve in the comments below – Since nobody really knows what inflation will be over a long enough period, I always use 3% – 4% just because it makes forward planning easy: just double your estimate for how much money you need to retire with for every 20 years until retirement]

The problem with financial advice – Part II

Why do you see a financial advisor?

ONE reason that people go, is because they expect that the financial advisor has great modeling tools, so they should be able to calculate your financial position and future needs with great accuracy.

What if I told you that doing your own financial planning using the simplest possible online tools and financial spreadsheets would get you closer – much closer – to your real financial needs than any ‘typical’ financial advisor can? What if I told you that is exactly the reason why I do my own financial planning using those exact same simple online tools and financial spreadsheets?

But, what if I told you that most financial advisors routinely underestimate your retirement needs by ~80%?

Would you even pay for such ‘professional’ financial advice again?

Need proof?

Well, a week ago I covered the first of best selling author, Dan Ariely’s comments about financial advisors, but he then goes on to say:

In one study, we asked people the same question that financial advisors ask: How much of your final salary will you need in retirement? The common answer was 75 percent. When we … asked where they got this advice, we found that most people heard this from the financial industry. You see the circularity and the inanity: Financial advisors are asking a question that their customers rely on them for the answer. So what’s the point of the question?!

In our study, we then took a different approach and instead asked people: How do you want to live in retirement? Where do you want to live? What activities you want to engage in? And similar questions geared to assess the quality of life that people expected in retirement. We then took these answers and itemized them, pricing out their retirement based on the things that people said they’d want to do and have in their retirement. Using these calculations, we found that these people (who told us that they will need 75% of their salary) would actually need 135 percent of their final income to live in the way that they want to in retirement.

This is a really important point; let’s say that your expected final salary is $100,000 in today’s dollars.

Then at 75%, you would need a nest-egg of $75,000 x 20 = $1,500,000

But at 135%, you would need a nest-egg of $135,000 x 20 = $2,700,000

[AJC: the ’20’ in the above calculations comes from my Rule of 20; see this early post]

That’s a shortfall in your retirement of $1,200,000 … more, if your expected ending salary is over $100k.

Now, what if I told you that I think your shortfall is not likely to be $1.2 million, but closer to $2mill – $3mill or even more?

I’ll let you know how I think you should calculate your true retirement needs in the next – and, final – post in this short series, because knowing what you’re aiming for now will stop a LOT of disappointment later 😉

Premature Retireration …

Don’t get me wrong, early retirement is great …

… not for everybody, mind you.

Many go back to ‘work’ because post-retirement life can become pretty boring, if you haven’t properly planned your time and your money.

I don’t include in ‘work’ anything where you are earning money because you want to, except where the commitment / stress / boredom rises to sustained uncomfortable levels and you feel that you can’t just walk away, in which case it’s probably ‘work’ just the same.

No, the real problem is that people don’t know when ‘retirement’ really begins:

They think it begins when they receive the huge card signed by 50 people they have hated for 40+ hours a week, or when the gold watch that they expected to receive turns into a Parker pen (in a nice box!), or when they get a nice speech from the boss who says: “Gee, we’ll really miss you, Bob” when your name’s John.

But, it really begins much, much later.

Ashton Fourie puts it best when he says:

This reminds me of a conversation I had with a friend after we sold our first business.

His comment then was, that having a pile of money, is not useful, because expenses continue to be a regular occurence. So we realized that one can only really “retire” when you have enough secure, passive income. Many people make the mistake to think you can retire on a pile of money.

Until you’ve figured out how to turn the pile of money into secure, long term passive income, you’re going to have to keep “working” – even if that “work” is the process of moving that money into income generating, secure, instruments.

This is really a very important observation and realization!

I remember being insanely jealous [AJC: slight exaggeration] of my friends who cashed out while I was still trying to earn a quid. Now, I am insanely jealous [AJC: this one is probably a huge exaggeration for dramatic effect] of those who still have a job or a business because they can spend pretty much whatever that want, knowing that next week the magic pot of honey will be refilled.

You see, it really is all about cashflow …

… when you have a pile of cash, you can only deplete it. Sooner of later it has to run out, no matter how much you started with, right?

Just ask [Insert big spending celebrity who’s financially crashed at least once in their lives: Elton John; MC Hammer; Willie Nelson; etc; etc] 😉

So, think about the early days of your retirement as a “transition phase” while you busily reassign your financial jackpot into income-producing investments then think about how much income those investments produce (after tax, various buffers for contingency, and reinvestment to keep up with inflation) and retire on that!

Brick Wall Retirement

[pro-player width=’530′ height=’253′ type=’video’][/pro-player]

Late last year we had some discussion about so-called “safe withdrawal rates” i.e. what is the ‘magic percentage’ that you can withdraw from your bank account (or other investments) each year, once you are retired, so that you don’t risk running out of money?

Jacob from Early Retirement Extreme said:

It’s fairly well-established (by the original Monte Carlo paper) that the 4% rule is only good for 30 years. Also it only pertains to a broad market total return portfolio. For shorter periods I’ve seen people quoting up to 7%. For longer periods, 3% or less seems to be in order.

He also suggested for a “more extensive discussions see Bob Clyatt’s book”, which we started discussing last week.

Bob undertakes a reasonably good strawman-analysis of some of the existing thinking on Safe Withdrawal Rates then uses some of his own analysis to come up with three rules:

1. It’s OK to withdraw between 4% and 4.5% of your portfolio each year, but

2. You only need reduce the $ figure of the previous year by 5% to cushion the effects of a down-market, as long as you

3. Follow his recommendations for a highly diversified portfolio of stocks, bonds, bicycles, and sausages.

[AJC: OK, I made up the bicycles and sausages bit ;)]

If you follow these rules, here’s your chances of NOT running out of money, depending on your time horizon:

Now, a few things bother me about this, indeed most discussions on this and other so-called Safe Withdrawal Strategies:

1. Here’s a bunch of people who generally advocate NOT to try and time the stock market, yet, in most cases (including Bob’s strategy, if you take the 5% option) you are trying to TIME the worst possible market of all: how long you expect to live!

2. There’s always a chance that your money will run out before you do – including  in 7 of Bob’s 8 (recommended as ‘safe’ and ‘sustainable’) categories; and, in the one ‘safe’category, you still have to run the gauntlet of a nearly 20% chance of perhaps losing your money for 2 whole decades.

3. Even if you wind down your % to Jacob’s suggested 3% withdrawal strategy, Bob’s numbers [AJC: you’ll have to see the book for this one] still show an almost 15% chance of losing your money in the first decade.

Now, there are other Monte Carlo studies that show that withdrawal rates on 3% to 3.5% are pretty damn ‘safe’ … BUT:

a) Personally, I expect to live forever and expect my money to do the same, and

b) How close to ZERO (but never quite reaching it, according to the statistical analysis of 3% – 3.5% withdrawal rates) do I allow myself to get before I panic?

I can’t help thinking that you need to substitute the words “safe withdrawal %” for “the right length and strength of vines” in the video, above, to really understand what it would mean to suffer a prolonged market downturn in retirement 😉

I’ve said it before, and I’ll say it again: unless you have a perpetual money machine set up, there ain’t no safety in withdrawal rates!

My retirement hypothesis …

I’ve said it before, and I’ll say it again, I think that personal finance in America is broken.

I say it’s broken because advice is being doled out without any qualification: work hard, be frugal, save hard and …

… and, what?

If you start after college, you’ll work 20+ (probably, 40+) years, and you will aim to retire on what kind of income?

Let’s take a quick look at Bristol’s case again; he is 23 years old yet: he already has a stable job; he invests in his 401k up to his company’s match%; he has $20k (split evenly between a savings account and some blue chip stocks).

He has run a few numbers through the CNN retirement calculator and realizes that, by age 55, he would need $5.9 mill. ($2.2 mill. in todays dollars) to “spend retirement happily”.

After some discussion, and more analysis, Bristol came to the conclusion that this is impossible on an 8% assumed after tax return.

Now, one of Bristol’s assumptions – and, one that I am guilty of supporting – is that he would need a minimum of $90k annual salary (today’s dollars) in retirement.

But, is that the case?

I can’t speak for Bristol – I don’t know how he came up with the $90k p.a. figure (hence, the $2.2 mill. today’s dollars nest egg requirement). And, maybe my view is skewed because we – and almost everybody that we know – need a LOT more than $90k a year in retirement (we’re budgeting for our current run rate of $250k – $350k per year to continue)?

So, do you think it’s acceptable to work for 20 to 40 years, be frugal, save hard, yet aim for less (keeping in mind the need to help support an adult family, partner, lifestyle, health … without any guarantees of government handouts and safety nets still being in place by then)?

The myth of semi-retirement …

We were driving through Sedona and stopped into some sort of Big Box Store to pick up some rubber beach shoes so that we could take the kids to Slide Rock.

We met a nice, older lady at the checkout and – as I tend to do with anybody and everybody – we got chatting.

Then she said something that took me totally by surprise:

She said that she moved to Sedona now that she is retired!

Retired?! Hang about, I thought, isn’t she standing at the cash register swiping my credit card?

Perhaps, reading my mind (more likely, the expression on my face), she clarified: she moved to Sedona when she retired from full-time work, and now that she is ‘retired’ (there it is again!) she only works part-time.

Why is that when you are studying – or perhaps slowly returning to the workforce post-parenthood – you are happy to tell your friends that you are “working part-time”.

But, when you reach 65 and suddenly find that you still need to work (perhaps with reduced hours, or in some sort of micro-business that you set up for yourself) you are “retired” or you are in that even less definable state of “semi-retirement”?

In fact, there are whole websites and books devoted to the subject of semi-retirement. One of those books is “Work Less, Live More” by Bob Clyatt; I bought it on the recommendation of Jacob from Early Retirement Extreme (he left a comment on this post) … I’ll be commenting on one specific aspect of this book (in fact, the very aspect that prompted Jacob to recommend it to me ) in an upcoming post.

In the meantime, Bob did confirm that I am not retired … I am semi-retired.

According to Bob, I am semi-retired because I do various income-earning activities: I still own a business; I own two development sites (and, am going though the process of having development plans approved by council); I have started an angel investing incubator (or, at least, started to put the foundations in place); have a web 2.0 startup and a book well under development.

But, if I am doing these things because I am a hobbyist, am I any different from the guy who is game fishing every other day as a hobby?

But, if I am game fishing every other day because I need the income (e.g. I take some paying clients out on my boat, or I sell the fish), am I any different to the guy who needs to have a part-time business – or blogs – because he needs the money?

In other words, isn’t the difference between working part-time and being semi-retired the need to bring in income from the activities that you undertake?

Doesn’t that change the dynamic just a little?

Even though he may enjoy the core activity, isn’t the part-time game fisherman who needs the money a little bit more upset when a trip is canceled due to bad weather (or customer cancelation) than the guy who is doing it purely because of his love of the sport?

Whether you agree or not, let’s at least agree on something … at least for the purposes of this blog:

1. If you are retired, you don’t need the money – you just do stuff for fun.

2. If you need the money, you aren’t retired, you are [insert activity of choice: writing a book; blogging; game fishing; real-estate developing; etc.] part-time.

The day that I need to consult to top up the income from my investments is the day that I am no longer just having fun: I’m working part-time.

Maybe we can coin a new term: flexi-working? Semi-working? Whatever you call it, there ain’t no retirement happening …

How about you? Where do you draw the line between work and retirement? And, does it even matter?