Friday, June 22, 2018

Is $3 million enough to retire? [updated 7/6/19]

How much do you really need in order to retire comfortably?

I was inspired by this article at, so I left my reaction in the form of a comment, which I've quoted below: 

40% in stocks when you retire? I'm not sure that's a good policy--it prioritizes growth at a time when stability is what you need.
Unless you go into retirement fully aware of the risks, and are already prepared for a downturn, keeping 40% in stocks when you retire is just *asking* to be blindsided! 
That said, I think the scenario you depicted above is an unlikely, worst-case sort of thing. On $3 million invested in bonds, assuming a 2% annual yield, you can expect $60,000 per year! [note: this $60K per year refers to interest income] And that's not to mention the safety of having so much invested that you could easily withdraw $10,000 or $20,000 per year to supplement your dividend income [note: this should read 'interest income,' not dividend income] without a reasonable fear of running out of money. 
Consider this scenario--you retire, and move your $3M into a cash account that pays no interest and incurs no fees. If you withdrew $60,000 per year, that $3M would last 50 years!!! Unless you live well into the triple digits, or the entire economy collapses as you described above and inflation runs rampant, it is unlikely that $3M is insufficient for retirement. 
Anybody who has $3M in investments and still doesn't feel comfortable retiring should re-evaluate his/her post-retirement investment strategy, his/her post-retirement lifestyle, or both.
I've already written at length about different strategies for retirement allocations, but I'd like to expound on these thoughts a little bit in this space.

TRS reports that he has heard people saying "$3 million isn't enough to retire on!!!" I suspect that those people are high-rollers (or people living in an expensive area like New York or San Francisco), who are used to spending over $100,000 per year.

Another possibility is that these folks have overly aggressive retirement strategies, predicated on keeping the majority of their retirement money in the stock market—an approach that I wouldn't recommend for most retirees.

The oft-cited Trinity study assumes you'll withdraw 4% of your retirement principal each year. This means that, if your "nest egg" neither loses nor gains any money, your principal will run out in 25 years. This assumption forms the basis for the counsel that most financial advisors provide to their clients.

Given that longevity data from the CDC, as reported here by Forbes, indicates that someone who is currently 65 can expect to live about 20 more years.

Based on the data cited above:

  • Ladies, you should plan for 20 years of post-retirement life. 
  • Guys, you can expect to live only about 18 years post-retirement—see Exhibit 1 
Therefore, the Trinity study's "4% rule" is a reasonable assumption. If your money will run out after 25 years and you only live for 20, then you'll have some money left over to leave to your family members and/or your favorite charities!

If everything goes well

So, let's assume that you've accumulated $3 million by age 65, and you're ready to retire.

The 4% rule means that you can convert your investments to cash, so you know that you have $3 million—no matter how the market performs—and you can then withdraw $120,000 per year on which to live.

Given that most Americans don't even make that much money before taxes, let alone after taxes, that sum would allow you to live out a princely lifestyle in a low-cost-of-living area (basically anywhere that's not a big coastal city like Boston, Atlanta, NYC, San Francisco, or LA).

But what if you just want a quiet retirement? You want to study things that interest you, volunteer, host an occasional party with family or friends...if you're in that boat, you most definitely don't need $120,000 per year!

I, myself, have lived on less than a tenth of that sum, and without incurring debt! I accomplished this by adopting the Millionaire Mindset...and you'd be wise to adopt it yourself!

If you think you "need" $120,000 per year when you retire, that's almost certainly due, at least in part, to your choices. I guarantee that there are options that don't require anywhere near that much money! Move somewhere with a lower cost of living, don't lease luxury vehicles, don't go to lavish parties all the time or drive all over the country, etc.

I don't think many people would maintain that they "need" a six-figure annual withdrawal, though. If you live in the city and that's where your family and friends are, you can move to the suburbs and take public transportation into the city when you want to visit. That will stretch your retirement funds quite a bit further than you'd expect!

In fact, if you can live on $60,000 per year after retirement, that $3 million nest egg will last a whopping 50 years. Please note that my parents' lifestyle currently costs less than half of that—for both of them! My father is employed and goes in to work every day, and still doesn't need close to $60,000 to support him and my mother combined!

So, barring unusual circumstances, it can be done.

In fact, when planning for retirement, many people assume a $1 million nest egg (not $3 million, a piddling one million!) and counsel the 4% rule, meaning that they expect retirees to live on about $40,000 per year.

Assuming that your house, your car, and any other expensive possessions have already been paid off, then that's totally do-able.

Complicating assumptions

Now, the real world is a lot more complicated than that. You cannot possibly know how long you'll live. Maybe you'll stay in good health and you'll live for 35 years post-retirement. If you retire at age 65, that means you'll live to 100 years old! Given the trend toward longer lifespans and better medical care, that's certainly not impossible.

Conversely, you may face some expensive, and unforeseeable, health problems.

Perhaps the stock market will take a 5% dive about a year after you retire!

To address this uncertainty, many people prefer not to withdraw their principal at all. Instead, they'd prefer to live off of the interest/dividend income generated by their investments.

Assuming a relatively conservative, bond-dominated allocation such as the kind I expect to use once I reach retirement age (see Example 2 here), this means that you'll need more than a measly (😉) $1 million portfolio.

Your bond-focused post-retirement portfolio will involve some of the stock market's ups and downs (you can expect more ups than downs over the long term), but will largely be stable in value thanks to the slow, steady appreciation of bonds. History shows that you can expect returns of roughly 4% in a total market bond fund.

Vanguard's low-cost VBTLX total bond market index fund, for example, has averaged returns of 4.04% since its 2008 inception (this is subject to change in the future, but it's accurate as of the time of writing, as pictured below).

That appreciation is due to a slow increase in value as the bonds draw closer to their maturity dates; this is distributed to shareholders as interest income. (For a more nuanced and accurate explanation, this is a good resource. But unless I've misunderstood something, my above statement is conceptually accurate. And I'm pretty sure that I haven't misunderstood it).

So, if you count 2% on a $3 million nest egg, that yields $60,000/year in dividends. Again, this is plenty on which to lead a modest suburban lifestyle, even without touching the principal. And, remember, you can still expect the nest egg to grow in the long-term!

If you take a conservative portfolio allocation and put 80% of your investments in bond funds in a tax-sheltered account like a 401(k) or 403(b) or a Roth IRA, this gives you $2.4 million in bonds; the other $600k can be in stocks, real estate, money market account, or whatever else floats your boat.

Assuming a 2% annual withdrawal on that $2.4M alone, this comes to $48,000/year of income, mostly tax-free (depending, of course, on how the tax laws apply in your case, whether those laws are changed, the type of investment account you hold the bonds in, etc. Ask your CPA for more detail on the tax implications for your particular circumstances, because that stuff gets complicated in a hurry).

Anyway, that sizable $3 million 'nest egg' can be expected to grow in small increments. Even if the value holds steady instead of appreciating, that $3M would give you a good amount of leeway to:
        a) handle unexpected and expensive medical treatments,
        b) live significantly longer than is typical, and
        c) handle unpredictable events like inflation.

Finally, I'll note that inflation eats away at money. Just as $1 million in 1920 had a lot more purchasing power than $1 million today, it's hard for a 25-year-old to predict how much things will cost in 2058. So, if you're under 30, it might be wise to aim a little higher than what you think you'll need in the future. You might be able to live on $20,000/year today, but things will assuredly cost more in the 2050s. Keep that in mind when doing your figuring.


So is $3 million really enough to retire on?

The short answer: Yes.

The longer answer? Assuming you'll live a modest lifestyle after retirement and keep a sizable portion of your investments (~80%) in the bond market—you can expect to live on more than $35,000 per year (after taxes, of course)...even without touching your $3 million!

If you want to supplement that by withdrawing an additional $10,000 one year, or exploring options to help pay tuition for your grandchild, then you still have plenty of room to do that as long as you adjust your plans (and your expectations) accordingly. And you'll still have a pretty nice principal to help you take care of extenuating circumstances (e.g. big family vacation abroad, health issues, etc.) if they arise.

Do I need $3 million to retire?

No. A retiree with no mortgage, car loans, or other debt could live comfortably on $40,000/year in 2018 dollars, unless living in a high cost-of-living area.

And if you're retired, you can choose to move to a lower cost-of-living area to stretch your retirement income. It doesn't have to be far away--just 20 minutes' driving time could potentially slash your bills in half! Remember that the Millionaire Mindset stresses the importance of minimizing your bills...

So how much do I need?

It depends on the lifestyle you want to live. $2 million should allow a comfortable lifestyle in most areas, even without touching the $2 million!

Assuming some interest/dividend income as well as supplementary withdrawals, I'd say that $1.25 million should be plenty for a modest lifestyle—even without counting any social security or pension payments!

I conservatively estimate that this $1.25M will generate around $20,000 in interest, allowing you to withdraw another $10,000 from the principal.

Under the assumptions that you'll spend $30,000 per year and nothing changes, you won't have to worry about running out of money unless you live 71 years post-retirement...

[Want to check my math? Here's a link to a spreadsheet that gives you the assumptions of this calculation, as well as showing my crude formulas].

Want to learn more about how to handle your money? Check out these 5 booksyou might be surprised by how much you learn!

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