Retirement! That very word is likely to bring a smile on everyone's face. The image of driving around in a golf cart or vacationing in some island comes to mind along with that radiant smile. Great authors like Chuck Carnevale and Regarded Solutions have written plenty about retirement here on Seeking Alpha.
However, as the comments section of a recent retirement article suggests, most investors are still ignoring two key pieces of the answer to the question "How much is enough"?. The following points dominate any discussion about retirement:
- You need a million dollars.
- Your retirement should not reduce your standard of living. If it does, you are better off working.
- Your retirement income should keep up with inflation.
- Keep up with the 4% rule.
So, what are the missing pieces? Expenses and the value/true meaning of retirement. And, just for the record, we do not agree with anything except point 3 in the "rules" mentioned above. Why? Because everything else depends on the never-ending contest between wants and needs. On the other hand, point 3 is valid for almost everyone because if living cost keeps increasing, purchasing power dwindles. Let us look at the other three points below:
Standard of living: How does one define that? Should one drive the same expensive car during retirement as one did during his/her working days? Is cutting down from a luxury car to say a Honda Civic considered a slash in the standard of living? Should one work an extra year or seek extra income to maintain that? Not in our books. Or does one still need to wear the costly Armani suits even if one is not working to prove there is no reduction in the standard of living? This section is likely to irk some as not everyone is talking about these items when it comes to standard of living but the point is, retirement does come in with added benefits of slashing down your standard of living aka expenses.
The 4% Rule and You need a Million Dollars: This is likely to bother even more people. How can someone slam the golden 4% rule? This comes from the same "You need a million dollars" school. 4% on $1 million gives you that magical $40,000 that you "need" each year during retirement. How does someone know how much I "need"? Since we love throwing around numbers and assumptions in these "simulation" articles, below is a breakdown of the living expenses of a comfortable retiree couple.
Assumptions: 1) Home paid off. If the couple prefers renting, feel free to substitute that. 2) No current expenses for kids. 3) The couple loves to eat very well and stay in shape. 4) Loves a very comfortable home (as one can see in the groceries, utilities, TV, and Internet bills) 5) Not too keen on extra luxuries like a new car or new set of clothes each year/month.
This monthly budget of $2,700 would be the envy of more than 90% of the world and make the eyes of some really cost-efficient people to bleed. Just for the record, we consider almost all these items almost excessive in cost and some of them could be outright eliminated. Even this budget leads to about $30,000 per year, leaving $10,000 for travel, one time expenses, doctor visits etc. The point is, the supposed $40,000 dollars to retire does and must have plenty of "wants" that most of us have become accustomed to, in addition to the few "needs" . At some point, we all must make the decision to put our time and value of freedom over the extra dollars. The biggest question is when, and to that there is no definitive answer.
If you are still not convinced that expenses do play a major role, if not THE ROLE, take a look at the chart below. Example: If someone is able to save 100% of his/her monthly salary and that is sustainable month after month, then that person is good to retire right now because living expenses are taken care of by things other than his/her monthly salary. If someone saves 50% of their take home paycheck, it would take 19 years for that person to retire, starting at zero dollars. How did we arrive at that figure, 19 years? Here is the calculation:
- This person has an annual (take-home) salary of $40,000 and lives on $20,000 and invests the other $20,000 at 5% yield. This means, the person has an annual expense of $20,000.
- The First column is the number of years to meet the living expenses through investment returns, the 2nd column is the annual take home, 3rd column is the savings rate. The table below uses 50% savings rate. But feel free to substitute your own. Column 4 is the assumed 5% after inflation investment return on your fresh $20,000 investment each year. Column 5 is the total return, including the fresh 5% and the returns on the previous returns (compounding).
- So, it takes this person about 19 years of saving 50% of his income, and investing that at 5% real returns to meet his living expenses through passive income.
- This is the worst case scenario, assuming the person has no salary increments, bonus etc. The key is not let such increases creep up your expenses as well (aka, lifestyle inflation).
Here is a flash news: it is not your income that determines when you can retire. It is your expenses. We've heard those stories all too regularly about people who blew millions and are struggling during retirement. If income is all that mattered, we wouldn't hear such stories. The table above can be customized for any income level, as it is columns C (Savings/Yr) and E (Investment returns) which have the major impact on Column A (number of years to retire). Notice that the "Snowballing Effect" column does not even take into account the annual income, it is the annual savings and investment returns that matter.
For more details, click on the "Source" link below the chart. This chart is a graphical representation of how savings rate impacts the number of years to retirement.
Sample Portfolio: Point 3 (keeping up with inflation) is where a dividend growth portfolio fits in. Mr. Carey's article had some great stocks to hold for and during retirement. Below are some of the stocks we would suggest for the same: The Coca-Cola Company (NYSE:KO), Johnson & Johnson (NYSE:JNJ), Exxon Mobil Corporation (NYSE:XOM), The Procter & Gamble Company (NYSE:PG), and Wal-Mart Stores Inc (NYSE:WMT). This is done mainly because readers need to take some stock specific recommendations from this article, in addition to general philosophy.
Mr. Carey had mentioned yield and dividend growth rate as key factors in his article. They sure are. We are presenting some more points retirees need to consider when buying stocks for income:
- Dividend Growth Streak: The most important aspect of all in our opinion as it shows the company has paid increasing dividends through thick and thin.
- Low Beta: Low volatility.
- Moderate Payout Ratio: Gives the company more room to increase dividends in the future.
Conclusion: For all the youngsters reading this, do not fall into the stereotypical trap and chase the $1 million or $3 million dream. How much you need is your own business, not anyone else's business to predict or suggest. In other words, what you need for retirement depends on what retirement means to you. For us, retirement means Freedom. The will to do whatever you want whenever you want (legally of course) without worrying about consequences. And to achieve that freedom there is no harm in pushing some items from the "need" category to the "want" category. Nowhere is "No one size fits all" more applicable than retirement. We urge readers and authors to be mindful and respectful of the fact that not every hard working individual can reach a million dollar in a life time. Does that make them lazy? No. Does that make them stupid? No.
Keep your expenses and the value of your freedom in mind before deciding how much do you need or what is enough. Example: If someone's intention of retiring is to spend time with family after running behind money his/her entire life, that costs almost no extra money. Sure, everyone needs (wants?) the odd vacation and luxury item but you should get the point by now.
So, what does retirement mean to you? And how much do you want? I mean, need.
Disclosure: I am long KO, MCD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.