How To Retire And Live To 100 With $875,000 In Net Worth

|
Includes: AAPL, BKH, CINF, CWT, DVY, EMR, HDV, HP, JNJ, KO, MCD, MMM, MO, NNN, NWN, O, PEP, PFF, PG, SDOG, SPHD, SWK, SYY, TGT, UVV, VIG, VVC, VYM, WMT, XOM
by: ColoradoWealthManagementFund

Summary

Follow along with me as Ted and Mary take the journey through a cautious retirement.

Ted and Mary face some unique risks with a goal of living to 100 and $875,000 in net worth prior to buying a house.

This strategy carefully plans for the cash flow needs of the couple, but there is no way to effectively prepare for each challenge.

The story of Ted and Mary has appealed to countless readers and given those who are retired or considering retirement soon an idea of what factors they may want to consider and how they might want to design their portfolio. This week I want to catch up with Ted and Mary as they navigate new environments.

Ted and Mary

The goal here is to make this hypothetical couple face situations that my readers may face. For this week, Ted and Mary will be in a scenario where Ted has 4 years left to go before he can claim his maximum social security benefit. Mary is younger and won't be filing until two years after Ted files. While Ted and Mary had a great career previously, after their firm outsourced Ted's entire division, he was forced to look for other work.

There was nothing in his previous field, but Mary found a part-time job that offered health insurance. Her entire paycheck goes to the health insurance and effectively cancels out the cost of health insurance.

Ted and Mary lived frugally and put away a material amount of money, but they didn't own their home and will need to buy a house.

The Challenges for This Week

Total cash prior to buying a house: $875,000.

An unexpected medical bill for $150,000 with complications a few years later running $25,000 and $15,000.

Nursing home care is eventually needed for Ted, but he lives longer than either of them expected.

Inflation runs at 1.7% throughout the retirement period.

Returns on the market are volatile and some of the dividend champions begin cutting dividends which hammers away at the dividend income.

A Sad Tale

If investors are familiar with the cost of medicine in America, they may already have a feeling in their gut that this week's adventures won't end as well for Ted and Mary despite their exceptional financial planning.

Building the Plan

Before Ted and Mary can decide what investments they should own, they need to assess their cash flow needs. They both believe that they have exceptional health and will live long enough to make it worth waiting to declare for social security. Individuals actually facing this scenario should seek a financial advisor that can help them with strategies to enhance their income from social security.

Ted and Mary look up the following chart to determine how their benefits will be impacted:

Click to enlarge

Lowering the Cost of Living

Even though Ted and Mary are in a fairly solid position with $875,000 before buying the house and a plan that will allow them to delay taking social security until they can get the maximum benefits, they still decide it would be best to focus on lowering the cost of living because Ted was not able to find a good job in their current city.

It is worth stating that if Ted could have found a good job in that city and was willing to work full-time for a couple more years, it might have provided a high enough salary to continue improving the value that would be used to calculate his PIA (Primary Insurance Amount).

Investors facing this kind of scenario should seek an ethical fee only planner that can provide them with exact figures to make an informed decision. The difference could be substantial. Far too often, investors will put off meeting with an advisor until after they are retired. It would be substantially more prudent to have that meeting at least a few years in advance.

Time Line

For simplicity sake, I'm going to use the assumption that the CPI increases actually reflect the rate of inflation in a retiree's living expenses.

For the first six years of the plan, Ted and Mary are expecting to have a higher annual budget that will allow them to travel more. When Mary shifts to taking social security in the 7th year they plan to stay home more and cut costs. The first 6 years use a budget of $50,000 adjusted for inflation in each year. Starting the 7th year, they are budgeting to spend the equivalent of $43,000 in today's dollars.

For those earlier years without the social security income there will be cash coming in from bank CDs. I hesitate to call this "income" because receiving principal back should not be confused with generating income.

With a reduced budget and a healthy payment from social security, Ted and Mary will be able to cover the majority of their expenses after they are both drawing, but they'll be using some dividend investments to cover the rest.

Allocation of Wealth in Dollars

I'm building the portfolio based on the projected expenses. Since social security is often treated as being similar to an inflation-adjusted bond fund in the sense of having consistent payments that increase gradually over time, I'm allocating substantially more of the portfolio to safer investments for the years prior to social security payments starting.

Click to enlarge

Because they are both going to be fully retired within 6 years, I can stick to using bank CDs instead of working in the treasury strips.

The Champions

The investor would be searching for stocks such as the following. Most companies on this list have over 40 years of dividend increases. Most have strong dividend yields. My screening criteria ensured that all except for one have both a trailing yield over 2% and at least 20 consecutive years of dividend increases.

Company

Ticker

Yield

Years

Northwest Natural Gas

(NYSE:NWN)

3.56%

60

Procter & Gamble Co.

(NYSE:PG)

3.27%

59

Emerson Electric

(NYSE:EMR)

4.13%

58

3M Company

(NYSE:MMM)

2.88%

57

Vectren Corp.

(NYSE:VVC)

3.63%

55

Cincinnati Financial

(NASDAQ:CINF)

3.11%

55

Coca-Cola Company

(NYSE:KO)

3.06%

53

Johnson & Johnson

(NYSE:JNJ)

2.95%

53

California Water Service

(NYSE:CWT)

2.75%

48

Target Corp.

(NYSE:TGT)

3.20%

48

Stanley Black & Decker

(NYSE:SWK)

2.40%

48

Altria Group Inc.

(NYSE:MO)

3.77%

46

SYSCO Corp.

(NYSE:SYY)

2.87%

45

Black Hills Corp.

(NYSE:BKH)

3.09%

45

Universal Corp.

(NYSE:UVV)

3.96%

44

Helmerich & Payne Inc.

(NYSE:HP)

5.80%

43

Wal-Mart Stores, Inc.

(NYSE:WMT)

2.96%

42

PepsiCo Inc.

(NYSE:PEP)

2.85%

43

Exxon Mobil Corp.

(NYSE:XOM)

3.60%

33

McDonald's Corp.

(NYSE:MCD)

3.02%

39

National Retail Properties

(NYSE:NNN)

3.89%

26

Realty Income Corp.

(NYSE:O)

3.94%

22

Apple

(NASDAQ:AAPL)

2.21%

4

Average

3.34%

44.61

Click to enlarge

The goal for this portfolio is going to be a yield of 3.44%. The portfolio is designed to grow dividends in a more stable fashion, but I'm assuming that this fails to materialize for Ted and Mary and their dividend income is hammered at the same time as the value of their investments.

Since the goal is 3.44% but the individual allocations only reach 3.34%, we know that the plan will require picking up a little extra yield. I will handle that by using some preferred shares. Since preferred shares tend to function like an annuity with the potential for a default by the company to abruptly end the payouts, it would be wise to assume that the preferred shares offer no growth in dividends. However, the 2% annual growth rate in dividends across the entire portfolio is very small.

Getting Diversification

Since the portfolio above may be a little too concentrated, I like to work in some ETF exposure. Ted and Mary will use the following 7 ETFs, but they won't get equal weighting.

Div. Yield

Expense Ratio

(NYSEARCA:VIG)

Vanguard Dividend Appreciation ETF

2.29%

0.10%

(NYSEARCA:VYM)

Vanguard High Dividend Yield ETF

3.11%

0.10%

(NYSEARCA:DVY)

iShares Select Dividend ETF

3.28%

0.39%

(NYSEARCA:HDV)

iShares Core High Dividend ETF

3.76%

0.12%

(NYSEARCA:PFF)

iShares U.S. Preferred Stock ETF

5.84%

0.47%

(NYSEARCA:SDOG)

ALPS Sector Dividend Dogs ETF

3.57%

0.40%

(NYSEARCA:SPHD)

PowerShares S&P 500 High Dividend Portfolio ETF

3.45%

0.30%

Click to enlarge

Because the individual stock portfolio was just barely below the average Ted and Mary were seeking, I'll only need to incorporate a small amount of PFF into the portfolio this time.

Breakdown of Holdings

The goal for cash flows from this portfolio in the first year was $10,850. This allocation strategy beats the expected yield by $27. That isn't a huge cushion, but forward yields should exceed trailing yields since I'm focusing on investments that have a history of growing dividends.

The Cash Flows

The following table demonstrates the cash flows:

Click to enlarge

The purple values for "surprise costs" indicate the impact of high costs for healthcare. In year 27, Ted enters a nursing home where he lives for another 7 years. The estimated cost of the nursing home is based off numbers pulled from LongTermCare.gov. I used their estimate of the average costs from 2010 and inflated them at a compound annual rate of 1.7%. When we are projecting 27 years out, it is not practical to be precise, so those numbers should be taken with a large grain of salt. I wouldn't be surprised to see long-term care prices increase substantially faster than the CPI.

It is also worth noting that I have not decreased income or living expenses in the final two years to account for Mary living alone because by that point the stock portfolio was too far gone for it to cover any material gaps in income. Customizing expenses at that point would be akin to rearranging the deck chairs on the titanic.

Portfolio Values

The model I built for these articles also works out the portfolio value in each year. Estimates on fair values for Bank CDs are a little rough since it requires estimating the appropriate discount rate.

Click to enlarge

It is worth noting that in this scenario I've used a cycling of growth rates for the portfolio value that suggests share prices and dividends increase at an average rate of 3.73%. However, to incorporate some elements of realism into the model, the growth rate includes substantially different values.

In year 35, the portfolio value goes bust. This is unfortunate because Mary had no intention of filing for bankruptcy. Some investors might think this problem could have been averted if Ted had simply carried life insurance. For our example, Ted lived to almost 100. If he paid for life insurance throughout retirement, he would've had to pay significantly more than whatever eventual benefit Mary received.

If an investor wants to use life insurance as part of their financial planning beyond their earning years, they should really get a financial advisor to assist them. Allow me to emphasize that getting a financial planner that sells life insurance to determine whether you need life insurance is like asking a car salesman if you need a new ride. I've seen people end up with policies they did not need and that did not make any economic sense.

The Investments in CDs

The following table shows the rates I used for the CDs, the amount invested, and the amount harvested.

Click to enlarge

You can check rates on certificates of deposit here.

A Great Effort

In this scenario, Ted and Mary made an incredible effort to get through retirement with a reasonable portfolio by working longer and budgeting diligently. I don't know of any method to reliably plan to avoid bankruptcy with several years in a nursing home outside of having at least a couple million at the start of retirement. This is simply the nature of the high costs. For investors that want to see how things would have turned out for Ted and Mary without the nursing home, see the chart below:

Click to enlarge

Without the nursing home costs, Mary would have had an inflation adjusted portfolio value of $673,683 in year 35. The portfolio was designed to withstand most potential scenarios outside of an enormous drawdown of the principal to pay high costs.

Don't Keep It To Yourself

If you found this article helpful, e-mail it to someone you think might enjoy it or tell me what you liked in the comments. From my research on what investors were reading and appreciating, I got the feeling the hypothetical story of Ted and Mary would be precisely what many retirees wanted. Even if there was something you thought was useless, you can let me know about that as well. The research took quite a while, but now that I have it in place I can run other hypothetical scenarios much easier.

Strangest Scenario

The strangest situation I covered for picking stocks was looking at stocks for a literal zombie apocalypse.

Disclosure: I am/we are long NNN, MO.

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.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.