Seeking Alpha

How To Retire With Just Half A Million

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Includes: ABBV, CRM, D, ET, FAGIX, FSPTX, GD, HD, HDV, JNJ, MAIN, MMM, MSFT, O, PFE, PFF, PRU, PSA, QCOM, SHY, T, TLT, UL, VFINX, VIG, VIGI, VNQ, VPU, VYM, VYMI, WFC, XOM
by: Financially Free Investor
Financially Free Investor
Long-term horizon, dividend growth investing, portfolio strategy
Summary

For retirement studies, the usual norm is to assume $1 million of investment assets. However, one size does not fit all.

We will consider an alternate scenario where our hypothetical couple, John and Lisa, did not have the means to save $1 million.

This time around, for John and Lisa, we will scale back their retirement savings goal to $500,000 by age 62, when they plan to retire.

We will analyze how they could still make it to a comfortable retirement while still growing their capital.

Most retirement articles and studies assume a scenario where a couple would have saved $1 million of assets by the time of their retirement. This is the most common norm. However, one size does not fit all. There would be many who would argue that $1 million is not the same as it used to be just a couple of decades ago. And there's certainly some truth to it. In fact, the new target for a comfortable retirement is closer to $2 million. Of course, some well-known experts have floated the idea of $5 million as a minimum threshold for a safe and comfortable retirement. Sure, for some, it may be true, but for the vast majority of Americans, it's neither achievable nor a requirement. So, how much money is required by a couple to retire at a bare minimum?

First and foremost, it's a subjective question, and the answer can vary greatly depending upon so many variables. But this is what we believe. There are at least three pillars that support a comfortable retirement, namely Social Security, Medicare and retirement savings. We are going to assume here that the first two pillars will survive, at least for the current retirees and anyone nearing 50 years of age or above, in spite of the political stalemate to find workable solutions. With these assumptions, this is what may be true for most folks:

  • $500,000 of retirement savings:

All basic needs are met, some luxuries can also be afforded. If invested with care, it can last 30-40 years.

  • $1 million of retirement savings:

Reasonably comfortable retirement with most middle-class luxuries that can be afforded. Money can last easily 30-40 years and significant sums can be left for heirs.

  • $1.5 - $2 million of retirement savings:

Highly desirable for a very comfortable retirement for anyone retiring now or in the next 10 years. If invested wisely, money can last perpetually.

  • More than $2 million of retirement savings:

If invested wisely, money should last perpetually/forever.

Retirement Planning With Half a Million

Obviously, it goes without saying that we should always aim higher and save as much as possible. That said, everyone's situation is different. We thought it would be worthwhile to look at a retirement planning scenario where the couple’s current income and spending habits/expenses are modest - hence their retirement goal should be much lower at $500,000. We will assume their current annual family income at $80,000.

Let’s assume that our hypothetical couple - John and Lisa – are both 50-years-old, and they plan to retire at age 62. If possible, they plan to work at least part time until 65. That should enable them to get to the age when they would be eligible for Medicare. Please note that since this couple currently makes $80,000, their spending needs are much more modest as well.

According to an article based on the data from the Bureau of Labor Statistics, “older households” spend an average of only $45,756 a year, or roughly $3,800 a month. Older households are defined as those run by someone 65 and older. This is about $1,000 less than the monthly average spent by all of the U.S. households combined. Also, please note that this is just an average, which means there are a lot of households that spend much less than $3,800 a month.

Keeping this in mind, we will assume that John and Lisa would need about inflation-adjusted $62,000 a year (or $46,000 in today’s dollars), assuming a constant 2.5% rate of inflation for the next 12 years.

Now, we also will assume that the couple will get anywhere between $36,000 - $42,000 of Social Security if they start the withdrawals at age 65 (after their Medicare deductions). However, if one (or both) of them need to start withdrawing at age 62, benefits would be 25% lower.

After subtracting $36,000 from $62,000, they would need to generate $26,000 of income from their retirement savings. If they had some kind of pension, they probably have nothing to worry about. But most folks don’t have that luxury anymore.

Assuming John and Lisa have a goal of saving $500,000, by age 62, they would need to generate 5.2% income to be able to withdraw $26,000 annually. We know that a withdrawal rate of 5.2% is higher than the traditional 4% rate, which most financial advisors suggest, they may have to make one or more of difficult choices.

  • At least one of them works part time, until age 65, preferably 67.
  • They could cut down their spending/expenses in retirement by at least $6,000 (per year) to bring their withdrawal rate to 4%.
  • Since they still have 12 years until 62, they could save more aggressively and aim for at least $700,000 of retirement savings.
  • Or a combination of some of the above.

Even though a 5.2% rate of withdrawal appears a bit over the top, we discuss some of the strategies that could comfortably deliver them 5% to 5.5% income, while conserving their capital.

Comparison of $1 Million vs. Half a Million Retirement:

$500,000 Retirement Scenario

The $1 Million Retirement Scenario

1.

Start of the retirement planning at 50 years of age

Start of the retirement planning at 50 years of age

2.

The current household gross income of the couple is assumed at $80,000 a year.

The current household gross income of the couple is assumed at $130,000 a year.

3.

Assumed starting savings-capital of $150,000 at age 50.

Assumed starting savings-capital of $300,000 at age 50.

4.

The couple could retire partially in 12 years at age 62, and fully by age 65 when they are eligible for Medicare.

The couple could retire in 12 years at 62 years of age.

5.

With moderate savings and with reasonable growth projections, their capital would grow to $500,000 plus by the time they are 62 years old.

By saving aggressively and with some reasonable growth projections, their capital would grow to $1.2 million by the time they are 62 years old.

6.

This couple could support post-retirement expenses of $62,000 (in inflation-adjusted prices), including social security payments.

They could support post-retirement expenses of $80,000 (in inflation-adjusted prices), including social-security support.

7.

They could start withdrawing their social security at age 62 (the earliest eligibility date), or one of them could work part-time and delay the SS withdrawals by a few years. Healthcare expenses from 62-65 may not be fully accounted for.

This couple could fully retire at 62, one of them taking social-security payments at 62 and another one delaying until 70 years. Healthcare expenses from 62-65 may not be fully accounted for.

Retirement Planning for John and Lisa

We make the following assumptions for John and Lisa:

  • At the age of 50 years, John and Lisa have already saved $150,000 in their 401K/IRAs. They decided to raise their 401K contribution rate to 10% of their income. They would also get an 80% match of the first 6% contribution from their employers. On their combined salary of $80,000, this would amount to $11,840 contribution/ addition each year.
  • They decide to retire at age 62 (for planning perspective) when they would actually be eligible for Social Security payments. They are planning for 62, but they may continue to work beyond 62, at least part time, depending upon how they feel at the time. By working part time until 65, they could delay the Social Security withdrawals and also reduce their spending on healthcare.
  • Assuming a very conservative return of 7%, and by regular 401K contributions, their retirement savings would grow to $500,000 plus by the age of 62.
  • Inflation and the average SS COLA adjustments are assumed to be at an average of 2%. The spending needs will be adjusted upwards every year for inflation and COLA adjustment.
  • House mortgage: After carefully looking at their financial situation, John and Lisa decide that they may not be in a position to put any extra money towards house mortgage principal. As a result, they may not be able to entirely pay-off the house before retirement at 62. Instead, they could downsize and move to smaller accommodation in retirement. Since they would not need to commute to work in retirement, they could move to an outer suburb where they could get a comparable but little smaller housing for about the same amount as their equity in the present house. As a result of this transaction, they also would pay less in property taxes and insurance on the new house.
  • John and Lisa determined that their starting expenses in retirement would be about $62,000 in inflation-adjusted terms or $46,000 in today’s dollars.
  • John and Lisa make their retirement planning based on the assumption that they would be able to get an average yearly return of at least 7% on their investments.

Though a 7% annual return is very reasonable, it's a very critical assumption that can make or break John and Lisa’s retirement planning. We will discuss strategies that can help achieve very modest targets of 7% to 8% return.

Below, we will present the investment results with two different rates of return, 7%, and 8%. With 7% or higher, their money will continue to grow, and they can hope to leave significant sums to their heirs.

Even with a 6% constant average return, their money can last until the age of 95 or so, but there's no scope left for any mistakes or unforeseen large expenses.

Results with 7% constant return:

Results with 8% constant return:

Note: To keep the table small enough and readable, after the 70th year, we have only presented net balances at the end of every five years.

The above examples show that the couple's investments grow in both cases. Of course, they grow much faster if the rate of return on their investment was 8%. A return of 9% or more will actually do wonders for their retirement balances. But even with a 7% return, they will be able to manage a comfortable retirement with their principal growing, albeit slowly. We have included the calculations until the age of 95 years.

Though the stock market has returned more than 9% on a long-term basis, however, there's no certainty of constant sequential returns. It can go up sometimes and can also go down a lot during recessions or major corrections. If a recession was to hit early in the retirement phase, it could be devastating on the retiree’s finances. So, all of this planning and calculations require that the retiree invests wisely and able to get an average return of 7% or higher. Some folks would argue that a 7% average return is too high to achieve - we tend to differ. We will provide some examples of strategies below to do just that.

How to Grow Your Investments at 7% (or Higher) Consistently

We can see from the above examples, the importance of the rate of investment returns that John/Lisa are going to get. This is critical in determining if they are going to have a very comfortable retirement or are they going to have to worry about money and cut corners.

However, fortunately, we are not aiming for some dramatically high rates of returns. We are only talking about 7%-8% returns on an average basis. The stock market has provided an average of 9% returns over long periods. But two things need to be kept in mind. First, this average is “over long periods,” and not necessarily the sequential return year after year. Secondly, this is just an average, and it means that so many retail investors get much lower and subpar returns due to several reasons, including keeping too much in cash, buying at the peak, and selling in panic situations. Below we will demonstrate how to avoid many of the above pitfalls and aim for at least 7%-8% overall returns consistently.

There are several ways to meet this goal. We have presented many strategies in our past articles. We prefer to adopt more than one strategy to provide strategic diversification. Below we present one such model.

Strategy Name

Allocation of funds

Income Goal

Total Return Goal

Maximum Drawdown targets

1.

Core DGI Strategy

Or DGI ETFs

40%

4%

9-10%

70-80% of S&P500

2.

Conservative High-Growth Rotation Strategy for Retirement funds (CHG Strategy)

50%

6% withdrawal

10-12% or higher

15-17%

3.

Treasuries and CD (Fixed Deposits)

10%

2-3 %

2-3 %

None

Author’s note: We provide many of the above strategies and portfolios in our Marketplace Service “High Income DIY Portfolios.”

The Core DGI Strategy

We present (see below) a sample DGI portfolio consisting of 20 names, a majority of which are relatively conservative, provide a decent dividend, and trading at a relatively cheap valuation. If you are putting new capital into the portfolio, we recommend buying in four or five separate lots spread over a year or so. This will avoid a situation where the market has a major correction just after you buy.

Sample List of 20 DGI Stocks:

Ticker

Close price 10/22/2019

Cap ($ Billions)

52-WK High

Distance from 52-High

Dividend yield %

Industry

Company Name

(GD)

179.88

51.96

193.76

-7.16%

2.33%

Aerospace/ Defense

General Dynamics Corporation

(MAIN)

42.38

2.68

44.35

-4.44%

5.79%

BDC/Financial

Main Street Capital Corp.

(T)

38.17

278.91

38.75

-1.50%

5.34%

Communications

AT&T Inc.

(UL)

59.17

154.36

64.84

-8.74%

3.10%

Consumer /Food

Unilever PLC

(XOM)

69.09

292.33

83.75

-17.50%

5.06%

Energy

Exxon Mobil Corp.

(ET)

12.7

33.36

17.04

-25.47%

9.49%

Energy

Energy Transfer LP.

(PRU)

91.21

36.67

106.4

-14.28%

4.40%

Financial

Prudential Financial, Inc.

(WFC)

50.62

223.04

55.04

-8.03%

4.04%

Financial/Banking

Wells Fargo & Company

(JNJ)

129.2

340.98

148.99

-13.28%

2.97%

Healthcare

Johnson & Johnson

(PFE)

36.43

201.5

46.47

-21.61%

3.95%

Healthcare

Pfizer Inc.

(ABBV)

77.87

115.13

94.98

-18.01%

5.54%

Healthcare/Biotech

AbbVie Inc.

(MMM)

167.54

97.19

219.75

-23.76%

3.52%

Industrial

3M Company

(O)

79.72

25.37

80.47

-0.93%

3.41%

REIT

Reality Inc

(PSA)

240.54

42

266.76

-9.83%

3.28%

REIT

Public Storage

(HD)

237.2

259.77

238.99

-0.75%

2.30%

Retail/Home-imp

The Home Depot, Inc.

(QCOM)

78.47

95.39

90.34

-13.14%

3.14%

Technology

QUALCOMM Inc.

(MSFT)

136.37

1049.42

142.37

-4.21%

1.47%

Technology

Microsoft

(D)

82.82

66.54

83.23

-0.49%

4.45%

Utility

Dominion Energy Inc.

(VYMI)

61.24

1.36

63.32

-3.28%

4.43%

International ETF

Vanguard Intl High Divi Index ETF

(PFF)

37.6

16.81

37.6

0.00%

5.56%

Preferred ETF

iShares Preferred Securities ETF

Average

169.24

-9.82%

4.18%

The Dividend ETFs Alternative:

Ticker

% Allocation

Dividend Yield %

Yield in the portfolio (as per allocation)

Fund Name

Expense ratio

(VIG)

15%

1.77%

2.66%

Vanguard Divi Appreciation Fund ETF

0.06%

(VYM)

15%

3.16%

4.74%

Vanguard High Divi Yield Fund ETF

0.06%

(HDV)

10%

3.33%

3.33%

iShares Core High Dividend ETF

0.08%

(VIGI)

10%

1.45%

1.45%

Vanguard Intl Divi Appr. Fund ETF

0.25%

(VYMI)

10%

4.43%

4.43%

Vanguard Intl High Dividend Fund ETF

0.32%

(VNQ)

10%

3.12%

3.12%

Vanguard Real Estate Index Fund ETF

0.12%

(PFF)

10%

5.56%

5.56%

iShares Preferred Securities ETF

0.46%

(AMLP)

10%

8.43%

8.43%

Alerian MLP ETF

0.85%

(VPU)

10%

2.81%

2.81%

Vanguard Utilities Index Fund ETF

0.10%

Total/ Average

100%

3.78%

3.65%

0.24%

The Conservative High-Growth Rotation Strategy

This strategy (CHG Model) aims for about 10%-12% average returns with minimal drawdowns. This strategy uses three mutual funds that can be easily used inside an IRA account. Besides, it uses two Treasury funds (ETFs) for the hedging mechanism. However, please note that at any point in time, we will only hold any two securities. Here are the securities/funds that are being used in the strategy:

  • (FSPTX) Fidelity Select Technology Portfolio Fund:

This is a Fidelity fund in the technology sector aiming to capture high growth by investing in top technology stocks. Some of the top holdings in the fund include Apple (AAPL), Microsoft (MSFT), Mastercard (MA), Alphabet (GOOG) (NASDAQ:GOOGL), Paypal (PYPL), Salesforce (CRM), etc. Even though we are using a high growth technology fund, with relatively higher risk, but this does not add high risk to the portfolio, because we are using it within a rotation strategy with a built-in hedging mechanism.

  • (FAGIX) Fidelity Capital & Income Fund:

This is also a Fidelity fund. It seeks to provide a combination of income and capital growth by investing in equity and debt securities.

  • (VFINX) Vanguard Trust 500 Index Fund:

This is the Vanguard fund equivalent of the S&P 500 index. You also could use the SPY etf in place of VFINX.

  • (TLT) iShares 20+ Year Treasury Bond ETF
  • (SHY) iShares 1-3 Year Treasury Bond ETF

Methodology:

We compare the previous three-month performance (including any dividends/distributions) of five funds/ETFs on a monthly basis and select the top two performers for investment on a 50:50 basis. The rotation period in our sample is on a monthly basis.

Comparison with the S&P 500:

Below we present the results from using this monthly rotation strategy for the last 15 years-plus (starting the year 2003) using our model portfolio and comparison with the S&P 500.

Year

CHG Model Return

S&P500 Return

Income Withdrawal

CHG Model Balance

S&P500 Balance

$100,000

$100,000

2003

44.85%

28.50%

0

$144,850

$128,500

2004

7.76%

10.74%

0

$156,090

$142,301

2005

-1.41%

4.77%

0

$153,889

$149,089

2006

13.29%

15.64%

0

$174,341

$172,406

2007

8.33%

5.39%

0

$188,864

$181,699

2008

6.66%

-37.02%

0

$201,442

$114,434

2009

62.17%

26.49%

0

$326,679

$144,747

2010

15.55%

14.91%

0

$377,478

$166,329

2011

21.75%

1.97%

0

$459,579

$169,606

2012

3.18%

15.82%

0

$474,194

$196,438

2013

20.65%

32.18%

0

$572,115

$259,651

2014

13.95%

13.51%

0

$651,925

$294,730

2015

-4.18%

1.25%

0

$624,674

$298,414

2016

-0.06%

11.82%

0

$624,299

$333,687

2017

27.76%

21.67%

0

$797,605

$405,997

2018

-0.80%

-4.52%

0

$791,224

$387,646

2019

11.63%

20.44%

0

$883,244

$466,881

The worst year for the strategy was -4.20% compared to -37% for S&P 500. The maximum drawdown was -16% compared to -51% for S&P 500. The annualized return for the strategy was 13.89% compared to 9.60% for S&P 500. The correlation with the US stock market dropped to 50%.

Results with 6% annual income withdrawn from each of the portfolios:

Year

CHG Model Return

S&P500 Return

6% Income Withdrawn

CHG Model Balance

S&P500 Balance

$100,000

$100,000

2003

44.85%

28.50%

6000

$136,159

$120,790

2004

7.76%

10.74%

6150

$140,098

$126,952

2005

-1.41%

4.77%

6304

$131,907

$126,404

2006

13.29%

15.64%

6461

$142,118

$138,701

2007

8.33%

5.39%

6623

$146,782

$139,197

2008

6.66%

-37.02%

6788

$149,317

$83,391

2009

62.17%

26.49%

6958

$230,863

$96,680

2010

15.55%

14.91%

7132

$258,521

$102,899

2011

21.75%

1.97%

7310

$305,849

$97,472

2012

3.18%

15.82%

7493

$307,844

$104,214

2013

20.65%

32.18%

7681

$362,147

$127,598

2014

13.95%

13.51%

7873

$403,696

$135,900

2015

-4.18%

1.25%

8069

$379,089

$129,428

2016

-0.06%

11.82%

8271

$370,595

$135,478

2017

27.76%

21.67%

8478

$462,641

$154,521

2018

-0.80%

-4.52%

8690

$450,320

$139,240

2019

11.63%

20.44%

8907

$492,749

$156,973

As one can see, the strategy performs a lot better than S&P500 over a 15-year period and at the same time, without the bumps. When the income is withdrawn (on a yearly basis), the strategy performs even better and ends with much higher balances compared to the S&P500. In the case of the S&P500, the retiree is forced to withdraw the income at times when the market is doing poorly, which results in overall inferior results.

Conclusion

We tried to demonstrate that even with just $500,000 of the starting capital (compared to the usual norm of $1 million), John and Lisa would be able to have a reasonably comfortable but modest retirement. Obviously, this strategy requires some sacrifices and compromises. We also demonstrated how small decisions could change the outcomes for anyone. So, planning is important and almost always dependent on personal factors and situations. There is, of course, no substitute for saving more and starting as early as possible. It's always better to aim for more rather than less.

If one had a long-time horizon, an investment in broad market indexes also could provide reasonable results, but the investor needs to be prepared for a bumpy ride and huge drawdowns at times. This is where most of the risk comes in since most people are not prepared for big drawdowns. The above example shows that a Rotation strategy can smoothen the ride, which will also result in higher returns, especially during the withdrawal stage.

We could see in the above examples how critical is the rate of return on our investments. It's important to invest wisely and grow savings on a consistent basis. In our examples, a return of less than 6% might result in a gradual depletion of John/Lisa’s savings into their 80’s or 90's unless they were able to reduce their spending. Two things stand out – first, we need to get a minimum of 7% return (for our portfolio to last perpetually) and secondly with minimum possible volatility and drawdowns. Fortunately, 7% or 8% is not a very ambitious growth target and highly feasible for most folks by avoiding the common pitfalls. Sure, it needs some knowledge, some work on a regular basis, and above all perseverance.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, UNH, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, PRU, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LMT, LYB, ARCC, AWF, CHI, DNP, EVT, FFC, GOF, HCP, HQH, HTA, IIF, JPC, JPS, JRI, KYN, MAIN, NBB, NLY, NNN, O, OHI, PCI, PDI, PFF, RFI, RNP, STAG, STK, UTF, VTR, WPC, TLT. 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: Disclaimer: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. Any stock portfolio or strategy presented here is only for demonstration purposes.