Updated: Dec 13, 2018
by William Sabin - Retirement Strategies
Circling back to the original question of how much money do you need to retire - the problem for most of us, but especially me, is that we're driven by fear and greed far too often. That goes for investing and living. While made popular by various movies and the media, those emotions are not what life is about.
There must be a way to be frugal and retire from the rat race and to be able to rewire yourself to follow your desires, work for yourself, give back to the community. But how? With over 30 years of investing and saving, I have a number of strategies to share below and in future articles.
The big question is, 'how much do I need to retire?' It really depends two main things: how long will you live and how much you will spend, net of earnings.
From the below stats, it's clear that we do not save enough. And most, do not have enough money to ever retire. Of course, Seeking Alpha readers tend to be more astute and mindful of retirement and the financial needs they will have, but this gives you a view of the ‘typical’ American.
1 In 3 Americans Have Less Than $5,000 In Retirement Savings
The report found that 33% of boomers have $25,000 or less in retirement savings. It appears from the above that most of us will not retire with a seven-figure portfolio. Will most people keep working forever? Is there a way to save more for retirement?
Guidelines & Portfolios
How can you know if you are spending in retirement at the right level?
The 4% Rule
There are a number of 'rules of thumb'. One is the four percent rule which is a rule of thumb used to determine the amount of funds to withdraw from a retirement account each year. This rule seeks to provide a steady stream of funds to the retiree, while also keeping an account balance that allows funds to be withdrawn for a number of years. Simply put, if you plan on spending $50,000 a year in retirement, you will need (according to this rule) $1,250,000 (50,000/.04).
I wanted to find a study that tested and back tested the 4% rule using inflation adjusted spending and entering retirement at various points over the last several decades. Fortunately, I found such as study.
The chart below shows the progress of retirees’ spending as a percentage of total assets based on the amount of inflation-adjusted spending halfway through their estimated retirement period. This chart shows the retiree’s then-current withdrawal rate as both the portfolio went up and down as well as shows inflation-adjusted spending requirements continuing to rise each year.
In this chart, lower numbers are better as it denotes the withdrawal rate is low and spending is modest relative to wealth. As Kitces states, someone that retired in 1966 found that they were, half way through the retirement period, the current withdrawal rate was above 10% with 15 years still to go. Fortunately, he states that the primary reason the 1966 retiree was able to finish retirement at all with such a high withdrawal rate was that their half-way point was 1981 when the stock and bond markets had gotten so cheap (yields had gotten so high) that the superior returns (and declining inflation) made it possible to finish successfully.
Looking at the 2000 or 2008 retiree, their results above continue to hover in the 4-6% range. The 2000 retiree is still only at a 6.2% withdrawal rate today (with just 15 years to go), while the 1966 retiree was over a 10% withdrawal rate at this point. And in the case of a 2008 retiree, the withdrawal rate is at the 4% initial withdrawal rate the retiree began with.
Of course, all of this depends on timing, spending, inflation, etc. The future does not always follow the past. However, it is reassuring that historically through markets ups and downs, that one can retire and live reasonably well.
Living on income alone
While many view the 4% rule as too conservative and that retirees should be spending more. I disagree. As an alternative to the 4% rule, many people are even more conservative by attempting to live on just income such as social security, dividends, and interest. While this is much harder to do and it will mean living with less. You will almost never run out of money in this scenario and you will be able to leave more to your heirs.
One might also consider a bond fund or bond laddering which attempts to match cash flows with the demand for cash using varying maturities that diversifies bond holdings within a portfolio. There are several good resources for developing a portfolio of bonds to provide you with the income that you need in retirement. I personally like what Fidelity Investments offers in this space. In short, laddering seeks to avoid reinvestment risk by not reinvesting a large portion of assets in an unfavorable interest rate environment. Each "rung" of the ladder represents a specific bond with a specific maturity rate and yield.
Get Ready for Retirement
Below are a few basics for those not quite at retirement:
Remember the value of compounding - save as much as you can as early as you can.
Always spend less than you make (some of my mom's best advice).
If you use credit cards, pay them off every month. No exceptions.
Make sure your investments work hard for you.
Put as much as you can into investments automatically each month.
Have a plan for healthcare. You might have to purchase a health insurance plan on the market or under the Affordable Care Act. Medicare generally doesn’t kick in until age 65.
In retirement, there are a number of lifestyle changes that you might be able to make, but they take more effort:
Budget. We budgeted for the first several years of our marriage. We started to budget again when we retired. Determine what your expenses are - what's fixed, what's variable and adjust accordingly.
Income Strategy. In conjunction with creating a budget, you will need to determine what your income will be and where your spending money will come from. When you enter retirement, your spending money will come from various sources instead of a paycheck. Part time job, social security, pension, investment income are all potential sources. More on this in the next section below.
Downsize. We have lived in big houses and small houses. There are several advantages to living in a small house. It's less costly to heat and cool. Taxes are most likely less. It is easier to maintain. The catch - let's get real here - it might not be something that people will drive by and envy. Isn't that why most of us live in a big house - to show others how successful we are?
Pick the best state. More on this later, but where you retire makes a big difference in cost and enjoyment.
Medical. This is one of the biggest expenses and you really need health insurance. Unfortunately, good insurance is expensive. Shop around. Analyze the risk of over and under insuring. Use generic prescriptions whenever possible.
Walk. We all need the exercise, so walk rather than driving. It will save gas.
Fewer cars. Do you need two or more cars in retirement? If not, sell one. Cut your insurance and maintenance costs in half.
Keep that car. Keep that car longer. Who are you trying to impress with a new, expensive car every couple of years?
Clothes. Have nice looking clothes, but don't go overboard. You are not going to the office anymore. Shop secondhand.
Communication. Apparently, everyone else stopped landline phone service years ago. Cut it. Shop for the mobile phone plan that you need and keep those phones longer.
Travel. With visiting almost 100 countries in my life, I'm all for traveling as much as possible. There are ways to see the same things everyone else does for a fraction of the costs - shop airline specials, book hotels that are safe and clean but not expensive. Why pay top dollar for a fancy reception counter and a pool. If you vacation right, you won't be spending much time at the hotel anyway.
Food. Eat at home more and cut back on eating out. Drink less booze. If you smoke, stop. It's better for your heath and wallet.
Shop. Shop around for the best prices. Buy what you need. Determine what is a need vs. a want.