You Don't Need $2.5 Million To Retire

Includes: COP, CVX, IBM, JNJ, KO, MCD, PG, SCG, SO, T, WMT
by: Eli Inkrot

You don't need $2.5 million to retire. Or perhaps you do, I have no way of knowing your individual situation, needs, expenses or preferences - but that point is neither here nor there. Recently I came across an article titled, you guessed it: "You Need $2.5 Million To Retire." What struck me about this article was that it was neither particularly egregious nor especially useful - which in my mind is outright dangerous as its conclusions would then seem "plausible." More specifically, the article actually does a reasonable job of pointing out the obvious: people need to be more aware of their financial situation, the sooner you start the better and paying yourself first can sidestep the psychological pain of delaying gratification. Yet using a blanket declaration like "you need $2.5 million to retire" is a misleading statement at best, a downright harmful one on the margin.

Incidentally, the financial consultant who was interviewed for the article never indicated that one needed $2.5 million to retire. Rather, he suggested that one might spend $2.5 million in retirement. (Publishing sensationalism at its worst I suppose.) Frankly I believe that even this number could be overstated, but let's work with this figure for a moment.

According to this website the average length of retirement in the U.S. is 18 years. Now I have no idea if this is an accurate statement, so to be on the safe side let's up the ante and call it 50 years. You can quibble about a decade here or there, but I would surmise that a 50-year retirement plan would take care of the majority of protests. According to the Bureau of Labor Statistics the average income before taxes for each "consumer unit" last year was $65,596 - or roughly $50,000 after taxes. Incidentally this is quite similar to the average annual expenditure per "consumer unit." Note that according to the BLS' data, a "consumer unit" consists of 2.5 persons, 1.3 wage earners and 1.9 vehicles. We'll keep things simple and call it a $50k salary for a couple.

Let's put these numbers - 50 years of retirement and $50k in annual salary - in context. With $2.5 million, the amount you must have according to the article, one could literally stack that hoard in cash and periodically take away $50k for the next 50 years. As astute readers of Seeking Alpha, I'm positive that you have discovered the fatal flaw in this assumption; yet it's interesting to note that on a nominal basis $2.5 million appears to be more than enough. Of course the error in this thinking is obvious: inflation. Fifty thousand dollars in 50 years time certainly would not be able to purchase the same amount of stuff as it would today. And as important as this point is, I would like to make two indications. First, I'm getting to that. Second, it can be all too easy to forget how fortunate we already are.

While $50,000 might be an average household mark in the U.S., it is by no means representative of the world. In fact, according to the Global Rich List an income of $50k would put you in the top 0.31% of people on the planet - that's 50 times the income of a laborer in Zimbabwe. True, there's a difference between income and wealth, but it's important to underscore nonetheless. It's not hard to see that even a $30k yearly expenditure mark would place you in the top portion of humanity; and not just with respect to the current civilization, but rather in the history of all mankind.

To simplify things, you could simply buy 30-year Treasury bonds with that $2.5 million and effectively keep pace with inflation. Even with the 30-year rate treading around a historically low 3.8%, this would likely protect one's purchasing power. Yet we're going to take it a step further. The reason that you don't need $2.5 million to retire is because there's this wonderful opportunity that we have called investing.

So how much do you need to retire? I have no idea, as I've likely never met you. But let's work through some examples. In keeping with the $50k example, while still accounting for inflation, it wouldn't be difficult to construct a dividend growth portfolio yielding an aggregate of 4%. For instance, mix some higher yielding companies like Southern Company (NYSE:SO), AT&T (NYSE:T) and SCANA (NYSE:SCG) with the likes of say McDonald's (NYSE:MCD), Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP) and you're well on your way. And that's without touching the high-yielding world of REIT's and MLP's.

In turn, it would only take a portfolio balance of about $1.25 million to achieve this - still sizable but markedly different than the other article's assumption. Of course you would likely want a few more names in there, but the point is that it isn't overly difficult to construct a portfolio that only needs half the capital that the article claims you need.

Plus, no one truly needs all that stuff they happen to buy. It's plausible that one might be able to live on less or else switch to lower yielding securities like Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ), IBM (NYSE:IBM) and Wal-Mart (NYSE:WMT). For that matter, it's conceivable that these securities might actually produce more income in the long-term anyway. Who says that you can't be happy living on $20k or $30k a year?

Taken to an extreme - if only slightly - if you can buy a house for say $300,000 and rent it out for a net profit of $15,000 and you can live on that amount, then you're effectively good. Your retirement number is $300,000, not something in the millions. And of course this holds true for a $300k dividend portfolio yielding 5% as well. Retirement amounts are highly individualized, but they're all based on the same math: income minus expenses.

With the above being said, I can imagine two common criticisms. The first deals with the size of one's "number." A complaint might come in the form of something along these lines: "sure I get the math, but saving up $1 million or $750,000 or even $300,000 is an exceptionally difficult thing to do." And I would agree to the extent that saving hundreds of thousands of dollars is a lot of money to put aside tomorrow. Luckily, we aren't bound by the timetable of accomplishing our goals in a day. Instead we have a lifetime, or at the very least a working lifetime, to fulfill these endeavors - not to mention the knowledge of compound interest at our fingertips.

The second objection would sound something like this: "you're forgetting about taxes!" Interesting, in our current tax environment this argument carries no weight. Perhaps the current rules will change, but if one had the funds today to live off dividends or capital gains they could have a healthy income without paying any taxes. That is, qualified dividends are taxed at 0% if one is in the 10% or 15% marginal tax bracket. In turn, this indicates that an individual could make say $30k or a couple could make $60k in dividends without paying a dime in taxes if this is their only income. You can argue about the fairness of this arrangement, but clearly the system rewards leisure over work. Granted this leisure might have indeed come from years or decades of above average hard work, but at the end of the day it's idleness that escapes the taxman.

Interestingly, there are some real life examples of this happening today. For instance:

The blog "Mr. Money Mustache" talks about a couple's experience of retiring at the age 30 by focusing on happiness and adhering to the "shockingly simple math behind early retirement."

"Go Curry Cracker" is also about a retired couple in their 30s that travel the world and plan on legally "never paying taxes again."

Or "Dividend Mantra's" tales reveal how small changes can have a momentous impact on one's financial well-being.

All of which demonstrate the power of math, eliminating unnecessary expenditures, focusing on the important aspects and determining what's truly significant in your life.

Yet as inspiring and motivational as all these stories happen to be, none of those examples are exactly the point. The bottom line is retirement is about income replacement, not figuring out a really big number. It's an individual concept, but the majority of people work because they have to, they need - or specifically want - a certain level of cash flow to go about their everyday lives. But it should be overwhelming clear that you don't need $2.5 million to retire; you might want that amount, but rest assured it is by no means necessary. Don't allow the media to push you into thinking "I'll never make that number, I should just give up." Instead, do the applicable math, make a plan and go for it! The idea of investing is to slowly but surely replace your income so one day your money is working for you, not the other way around. So, what's your true retirement number?

Disclosure: I am long COP, CVX, IBM, JNJ, KO, MCD, PG, SO, T, WMT. 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.