Getting Ready for Retirement

How much money will you need for retirement? This obviously is very important question, but also a very difficult question to answer. There are many factors and assumptions that go into estimating the income that will be needed in retirement. With so many estimates and assumptions, there is a high probability the estimated number will be incorrect.

This past summer BusinessWeek week ran an article in which Brett Hammond, TIAA-CREF’s chief investment strategist, shared an easy way for people to check on their retirement readiness. Here are some of the major points from the article:

• Hammond’s calculations start with one of the basic tenets of retirement planning—that people need at least 70% of their pre-retirement income during post-working years.
• If you’re 35 and plan to retire at 65, you need 2.1 times your salary to be on track.
• By 45, you had better have 3.6 times.
• At 55, the multiple rises to 5.4 times.
• And by the time you retire, you’ll want it to be 7.7 times.
• He assumes a 10% contribution rate, 4% salary growth, a bit ahead of inflation; a 6% return on investments; and a 25-year retirement period to finance.

If your investments are growing at 6% every year and you are withdrawing 4% each year, then you will not run out of money, even with 2% inflation. The problem that I have with such estimates is that market does not move in a straight line. What happens when the market tanks?

Consider 2008 when the S&P 500 lost a third of its value. A retiree will still have bills and thus need to withdraw a certain amount of dollars. This dollar amount is likely fixed, which means it will be more than the 4% estimated. For example, if your living expenses are $40,000/year, you would need a one million dollar portfolio to support it if you limited your withdrawals to 4%. Assuming your portfolio lost 33% in 2008, that would leave you with $667,000 dollars. Taking a flat $40,000 from it would result in a 6% spend rate, more than the 4% maximum many experts cite. Another alternative would be to limit yourself to 4% which would be only $26,680, well below the $40,000 needed.

Once you get behind it is hard to catch up. Let’s say you spend the full $40,000 needed to meet your expenses, this leaves you with $627,000. To get back to the one million needed to generate the needed income of $40,000 at 6%, your portfolio would have to grow by 59% in 2009.

To mitigate the risk associated with relying solely on capital appreciation, consider introducing an income component to the equation. In addition to bonds, some high-quality lower risk dividend stocks could help provide a steady income allowing you to rely less on selling securities to harvest their capital gains. Of the 107 dividend stocks that I currently only 5 carry the lowest risk rating of 1.00. They are:

Sysco Corp. (SYY) – Yield: 3.70% – Analysis
SYSCO Corporation, through its subsidiaries, engages in the marketing and distribution of a range of food and related products primarily for foodservice industry in the United States and Canada.

Johnson & Johnson (JNJ) – Yield: 3.20% – Analysis
Johnson & Johnson engages in the manufacture and sale of various products in the health care field worldwide.

Procter & Gamble Co. (PG) – Yield: 3.20% – Analysis
The Procter & Gamble Company (P&G) is focused on providing branded consumer goods products. The Company markets its products in more than 180 countries.

PepsiCo, Inc. (PEP) – Yield: 3.10% – Analysis
PepsiCo, Inc. (PepsiCo) is a global snack and beverage company. The Company manufactures, markets and sells a range of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages and foods.

Wal-Mart Stores, Inc. (WMT) – Yield: 2.20% – Analysis
Wal-Mart Stores, Inc. is the largest retailer in North America. The company operates retail stores in various formats worldwide. It operates through three segments: Wal-Mart Stores, Sam’s Club, and International.

Astute entrepreneurs will tell you it is good to diversify your income streams to minimize the risk of one or more of them drying up. The same is true in retirement planning. We shouldn’t rely on any single income stream (social security, pension, 401(k), etc.), but instead look to diversify our income streams. Quality low-risk dividend stocks make an excellent addition to our retirement portfolio, and the good new is, you don’t have to wait until you retire to figure out what income it will generate.

Full Disclosure: Long JNJ, PG, PEP, WMT, SYY. See a list of all my income holdings here.

(Photo Credit)

Comments

[The Recusant:]

Even these "safe" stocks listed will take a tremendous hit when the next step down occurs. If one is preparing for retirement...I'm not, I'm already retired...then one should seriously consider putting from 10-20% in gold and silver related stocks. No, I don't consider myself a goldbug, just open to the likely possibility that a downturn is in motion due to excessive overbuying in the market and a likely inflation next year or after. If you do consider investing in the PMs, though, stay clear of some of those risky ETFs that most analysts tout. It would be better to invest in the miners or hold physical gold or silver in your safe deposit box. Good luck.

Sep 22 01:50 PM

[sticktoitiv...:]

"Hammond’s calculations start with one of the basic tenets of retirement planning—that people need at least 70% of their pre-retirement income during post-working years."

What does income have to do with it? It's expenses you have to worry about.

Sep 22 02:21 PM

[Mad Hedge F...:]

mgx A number of readers have asked me to come up with a safe, high yielding investment in which to hide out in case the equity markets swoon again. That means they are looking for a security that offers a high fixed return, denominated in a strong currency that will benefit from future upgrades that will boost the principal over time. All of that is another name for the Invesco PowerShares Emerging Market Sovereign Debt ETF (PCY). The fund has 40% of its assets in bonds issued in Latin America and 31% in Asia, with the bulk of the maturities exceeding ten years. The two year old fund now boasts $340 million in market cap and pays a handy 6.42% dividend. This beats the daylights out of the nine basis points you currently earn for cash, the 3.40% yield on 10 year Treasuries, and still exceeds the 6.42% dividend on the iShares Investment Grade Bond ETN (LQD), which buys predominantly single “A” US corporates. The big difference here is that foreign bonds are issued in strong foreign currencies instead of weak dollars, and have a rosy future of further credit upgrades to look forward to. It turns out that many emerging markets have little or no debt because until recently, investors thought their credit quality was too poor. No doubt a history of defaults in Brazil and Argentina in the seventies and eighties is at the back of their minds. With US government bond issuance going through the roof, the shoe is now on the other foot. A price appreciation of 125% over the past year tells you this is not exactly an undiscovered concept. Still, it is something to keep on your “buy on dips” list.

Sep 22 02:51 PM

[CNGfamily:]

"What happens when the market tanks?" I find it refreshing that the sequence of return and "reverse compounding" issues are recognized. Thank you!

Sep 22 03:50 PM

[notsosmart:]

right on-buy on dips.

Sep 22 03:52 PM

[SeekingTruth:]

D4L, Thanks for some solid and useful data and suggestions. MadHFT pitched in with an excellent comment and suggestions as well.
Dividends are vital to the casual investor on a long term basis , not only to the retirement candidate, but for long term investment survival for the small and casual investor, at least with a reasonable percentage of his portfolio - more as retirement nears. It is an art and science more complicated than many realize, and articles like yours alleviate the strain and effort considerably.

It is worth recognizing that the S&P 500 is at a level first seen in Feb. 1998, more than 11 years ago. i.e. Flat for over 11 years on a growth basis for buy and hold investors.
Message : Don't buy and hold mindlessly, even better dividend paying stocks should be let go when overvalued, but only with great caution and care with the mind and strategy to buy them back along the way, or to improve and update your selections..
Again thanks for a good and useful article , you do us an excellent service, also MadMFT.

Sep 22 06:24 PM

[Dividends4Life:]

Mad Hedge Fund Trader: I found your recommendation of PCY intriguing. Having never looked at it before, I ran some quick numbers on its dividend comparing it to LQD. Surprisingly, its standard deviation from 11/07 to 9/09 was 0.01489 compared to 0.02817 for LQD over the same period (Yahoo data + iShares to fill in some LQD blanks). LQD is one of my core bond holdings, but it is quickly approaching full allocation, so I've been looking for some other alternatives. A higher yield and lower standard deviation on its dividend makes PCY worth looking deeper into.

Thanks for mentioning it!

Best Wishes,
D4L


On Sep 22 02:51 PM Mad Hedge Fund Trader wrote:

> mgx A number of readers have asked me to come up with a safe, high
> yielding investment in which to hide out in case the equity markets
> swoon again. That means they are looking for a security that offers
> a high fixed return, denominated in a strong currency that will benefit
> from future upgrades that will boost the principal over time. All
> of that is another name for the Invesco PowerShares Emerging Market
> Sovereign Debt ETF (seekingalpha.com/symbo...). The fund
> has 40% of its assets in bonds issued in Latin America and 31% in
> Asia, with the bulk of the maturities exceeding ten years. The two
> year old fund now boasts $340 million in market cap and pays a handy
> 6.42% dividend. This beats the daylights out of the nine basis points
> you currently earn for cash, the 3.40% yield on 10 year Treasuries,
> and still exceeds the 6.42% dividend on the iShares Investment Grade
> Bond ETN (seekingalpha.com/symbo...), which buys predominantly
> single “A” US corporates. The big difference here is that foreign
> bonds are issued in strong foreign currencies instead of weak dollars,
> and have a rosy future of further credit upgrades to look forward
> to. It turns out that many emerging markets have little or no debt
> because until recently, investors thought their credit quality was
> too poor. No doubt a history of defaults in Brazil and Argentina
> in the seventies and eighties is at the back of their minds. With
> US government bond issuance going through the roof, the shoe is now
> on the other foot. A price appreciation of 125% over the past year
> tells you this is not exactly an undiscovered concept. Still, it
> is something to keep on your “buy on dips” list.

Sep 22 06:31 PM

[Teak:]

The S&P may have been flat over the past 10-11 years, but someone holding blue-chip dividend paying stocks over that time period would have achieved an annualised growth of +5.4%. Not everyone owns a S&P 500 index fund.

On Sep 22 06:24 PM SeekingTruth wrote:

> D4L, Thanks for some solid and useful data and suggestions. MadHFT

> It is worth recognizing that the S&P 500 is at a level first
> seen in Feb. 1998, more than 11 years ago. i.e. Flat for over 11
> years on a growth basis for buy and hold investors.
> Message : Don't buy and hold mindlessly, even better dividend paying
> stocks should be let go when overvalued, but only with great caution
> and care with the mind and strategy to buy them back along the way,
> or to improve and update your selections..
> Again thanks for a good and useful article , you do us an excellent
> service, also MadMFT.

Sep 22 08:14 PM

[Old Trader:]

TEI and GIM are a couple of other foreign debt funds to consider. TEI is primarily emerging markets, GIM is global sovereign...both are run by Templeton.

Disclosure: I hold both.

Sep 22 08:16 PM

[Lightway:]

Compared with many of the equities mentioned above, PCY's dividend does not have a history of growing over time, however, the payout seems to have been consistent, which is what you want to counter when equity total return goes south:

www.buyupside.com/divi...

Sep 22 09:36 PM

[David Van K...:]

"Hammond’s calculations start with one of the basic tenets of retirement planning—that people need at least 70% of their pre-retirement income during post-working years."
-----
This "basic tenet" is a very misleading generalization, far off the mark for many people.

What counts in retirement (I am retired) is a combination of income + withdrawals from your nest egg that meet your expenses. 70% of your pre-retirement income is such a crude way to estimate that number that it might be said to be uncorrelated with it. Instead, create a retirement budget. Your expenses will not be the same as when you were working. Less on clothes, more on travel, etc.

Thanks to the various commenters who mentioned non-traditional sources of income. I agree with the author that dividend stocks are an important source; I own a bunch.

Sep 23 09:07 AM

[YoYoMama:]

Thanks for the tip on PCY. The expense ratio on this CEF is only .5%, which is way below average.

I have had JGT, which is a multi-government bond CEF, and AWF, an emerging markets bond CEF, for a while, and both have performed steadily and admirably, with nice steady dividends.

On Sep 22 02:51 PM Mad Hedge Fund Trader wrote:

> mgx A number of readers have asked me to come up with a safe, high
> yielding investment in which to hide out in case the equity markets
> swoon again. That means they are looking for a security that offers
> a high fixed return, denominated in a strong currency that will benefit
> from future upgrades that will boost the principal over time. All
> of that is another name for the Invesco PowerShares Emerging Market
> Sovereign Debt ETF (seekingalpha.com/symbo...). The fund
> has 40% of its assets in bonds issued in Latin America and 31% in
> Asia, with the bulk of the maturities exceeding ten years. The two
> year old fund now boasts $340 million in market cap and pays a handy
> 6.42% dividend. This beats the daylights out of the nine basis points
> you currently earn for cash, the 3.40% yield on 10 year Treasuries,
> and still exceeds the 6.42% dividend on the iShares Investment Grade
> Bond ETN (seekingalpha.com/symbo...), which buys predominantly
> single “A” US corporates. The big difference here is that foreign
> bonds are issued in strong foreign currencies instead of weak dollars,
> and have a rosy future of further credit upgrades to look forward
> to. It turns out that many emerging markets have little or no debt
> because until recently, investors thought their credit quality was
> too poor. No doubt a history of defaults in Brazil and Argentina
> in the seventies and eighties is at the back of their minds. With
> US government bond issuance going through the roof, the shoe is now
> on the other foot. A price appreciation of 125% over the past year
> tells you this is not exactly an undiscovered concept. Still, it
> is something to keep on your “buy on dips” list.

Sep 23 09:22 AM

[mbkelly75:]

You could do what I did (and have recommended to others over the years). Find for sure what it takes to live comfortably on a daily basis.
You do this by writing down EVERYTHING you spend money on during the 24 hour day - nickel on gum - write it down - $10 on lunch - write it down. Keep this log for 3 months (even the IRS considers a 3 month record as accurate to use for estimates of yearly expenses). At the end of this time - you will know several things about your spending - but the one that counts here is what does it take for you to live comfortably for a day. This is different for everyone - I am comfortable and have more cash than I know what to do with at $50/day - my sister and her family in Southern Cal need nearer to $300/day.

When your dividend-paying stocks and bond-interest income is equal to what you need to live comfortably (passive income) - you can retire. I remember a celebration when we reached financial independence for 1 day/year. It was a good feeling. I have long since reached my retirement this way and it does work. Think about it.

Sep 24 11:12 AM