The year 2022 is turning out to be a tough one for all stripes of investors. The market is giving warning signals of a looming recession. Sure, there's a lot to worry about, 40-year high inflation, record-breaking energy and gas prices, rising interest rates, the sinking investment portfolios, just to name a few. But even then, there's no reason that you should not think of planning a successful and rich retirement with stock investment. In fact, the opposite.
We want to show our readers, especially the new and relatively younger investors - what's possible with starting and investing early for the future. The earlier you start, the easier the path will be. Even if you're late to investing and saving for the future, there's no reason to be disheartened. After all, it's better late than never, and there are ways to make up for the lost time. If you're already into your late 40s or even 50s, you can still achieve financial freedom - it will just require a little more sacrifice and determination.
So, why does everyone talk of a million dollars? A million dollars is simply a milestone. For some, it could be a very tall target, while others may think it to be insufficient to retire. So, it can vary based on your individual perspective and your current way of life. But for most everyday working folks, the first time you hit a million-dollar mark in retirement savings, it's an important achievement. Sure, a million dollars is not the same as it used to be just two decades ago. Most financial planners would now advise shooting for $2 million to have a comfortable retirement. Due to inflation, since early 2000, the buying power of one dollar has reduced to less than 60 cents today, and that's not counting the current bout of high inflation. So, even with that basis, now you would need over $1.6 million to maintain the same standard of living as you could afford with one million in the early 2000s. In fact, folks who have retirement 20 years away should definitely target 2 million to retire comfortably.
But these are just hypothetical numbers, and they can vary greatly from person to person, depending upon current income, basic living expenses, health status, personal spending habits and hobbies, availability of other sources of fixed income like pension and social security, and most importantly, the place where you decide to live in retirement. Always start with reasonable and achievable goals first, and once you have achieved the first set of goals, build on them by setting new and higher targets.
To plan for retirement, you may have to answer some of the basic questions:
The above questions are critical to the planning process. As such, these questions are interrelated and interdependent. As such, there are no pre-set or generic answers, but we prefer to answer them in the above order. So, how much money would you need in retirement for your basic expenses on a monthly basis? It's mostly determined by your personal situation. We will try to answer this and other questions on a methodical basis in the next section.
For the vast majority of people, Social Security and Medicare play an important financial role in their retirement planning. For Social Security purposes, the full retirement-benefits age is considered 66 years, which gradually rises to 67 years for folks born in 1955 or later. The early Social Security benefits become available at age 62, albeit at 25%-30% lower rates. Medicare plans become available starting at age 65, which is essential for many folks to be able to retire. So, because of medical insurance necessity and Medicare eligibility at 65, most working folks plan to retire at 65. That said, we think one also should have a contingency plan to be able to retire a few years early (say at age 62), just in case it's forced upon by any circumstances.
Let's say you and your spouse just turned 55 and have not given serious thought to retirement. Well then, there's not much more time left to wait. It's probably high time that you make a plan and put it into practice. For the purpose of this article, we will consider a couple who have just turned 55 and want to be prepared for retirement in 10 years.
Note: This article is part of our Retirement Series, where we write periodically (a few times a year) on retirement themes. Each time, our focus is on a specific set of circumstances and age groups. At times, you may notice some repetition of some core principles and strategies, but they are necessary for the benefit of new readers.
All of the tables and charts in this article have been prepared by the author unless explicitly specified otherwise.
As usual, to make it easy to understand the concept, we would use our hypothetical couple - John and Lisa - to demonstrate the planning process.
Let's assume John and Lisa are 55 years of age and wish to retire in 10 years at 65. It's possible that they would change their mind in the future and may decide to work longer, but the idea is to be prepared to retire by the age of 65 or even sooner if they had to. We will assume that they both work full time, and their current household gross income is $130,000 a year, which falls solidly in the middle-class income group.
Their current savings are respectable at $350,000 but nowhere close to enough for their age bracket. They're mostly invested in tax-deferred plans like 401K and/or IRAs. Now, this is not a very large sum at their stage, but it's not too bad either. We also have to account for the fact that the market has done exceedingly well in the last decade, except in the recent months, and the next decade may not be as good as the last one.
In any case, they have done a good job of accumulating the current savings of $350,000. Unfortunately, it falls short of their goal to retire by the age of 65 and be able to maintain their current living standards. According to financial planners, their savings at this stage should have been about 5-7 times their current gross income. In other words, it should have been at least 650,000. So, John and Lisa are clearly lagging. The first thing they do is to recognize that their current savings are not enough, and they need to make some tough choices if they hope to have a comfortable retirement starting in 10 years. They would have to make some sacrifices now and cut down some of their discretionary spending in order to save and invest more.
While trying to plan for their retirement:
Let's make some more assumptions about John and Lisa's situation.
Table 1: John and Lisa's New Budget (estimated) vs. Old
** The author is not a tax expert/consultant. This estimate is just to provide a broad idea for the purpose of demonstration; the actual amounts could vary.
To know the total savings requirement, they will need to first estimate their expense in retirement.
There are several ways to work out an estimation of expenses in retirement. Different people in similar situations will probably come to different conclusions. That's why it's important to keep some flexibility, and one should plan for a 10%-20% variation from year to year. We list some of the ways to get started:
Based on the first method, this is what John and Lisa came up with:
Table 2: Expenses in Retirement (broad estimates)
In the above example, it's easy to see that nearly 55% of their current gross income goes to expense items that they will no longer have or need in retirement. However, these are not universal numbers and can vary greatly based on individual situations. That said, for John and Lisa, it means that they should only require roughly 45% of their current gross income to support their existing lifestyle. However, to be a bit cautious, we would increase it to 50% of their current gross income, which comes to $65,000 a year at today's prices. However, due to inflation in the next 10 years (assuming a long-term average of 3% a year), they will require $88,000 a year. This is assuming that the current bout of extremely high inflation (nearly 9%) should not last, or we are going to have much bigger problems. Please note that we have also provided a cash reserve of $100,000, more than the living expenses for one year.
Table 3: Expenses in retirement after inflation
50% of the current gross income:
Inflation-adjusted Amount (10 years later):
$88,000 a year
Since John and Lisa have worked out their yearly expenses budget in retirement, they can easily determine how much of the total savings they would need by the time they retire.
In fact, John and Lisa have a few options to consider with regard to the optimal age when they should draw on Social Security:
Each of the Options (1 and 2) has their pro and cons and should be considered carefully. If you expect to live a long life, then it would be better to delay Social Security withdrawals until the age of 67 years (or 70 years). Also, as explained above, the spouse whose Social Security benefits are likely to be larger should preferably delay the withdrawals. We will consider option 1 in detail. They would withdraw roughly 5%-6% from their portfolio from 65-70 years of age. Even though a withdrawal rate of 5%-6% may seem to be too high; however, as it's demonstrated in the table below, this could be easily done since it's for a limited window of five years, after which the withdrawal rate would fall significantly to less than 2%. They could obviously withdraw more once in a while for emergencies or some special occasions.
Let's consider Option 1 in more detail:
Both John and Lisa retire at 65. They do not opt for part-time work. John will take Social Security benefits starting at age 65, and the approximate benefits are assumed to be $2,400 per month or $28,800 per year (after counting inflation increases). Since Lisa will wait to withdraw SS benefits until 70, her benefits will be much higher at approximately $3,600 a month or $43,200 a year (after counting inflation increases). They will reserve $100K in cash (more than one-year of expenses) from their retirement portfolio.
By doing some reverse calculations, here is what they would need:
Table 4: Calculation of savings needed
So, this couple will need at least $1.1 million at the time of their retirement at 65 years of age. As the calculations below will demonstrate that they can easily reach their target if they can get at least 7.5% average annual returns over the next ten years. We think it's very reasonable and doable to get at least 7.5% average annual returns. In fact, we will show in the later section how to achieve safely 10% returns on a long-term basis.
As is clear from above, John and Lisa have defined their savings target. Now they need a plan that could get them from $350,000 to $1.1 million-plus in 10 years. They assume that their investments would grow at a very conservative rate of at least 7.5% a year for the next 10 years, while they contribute 18% of income every year along with employer's matching (assuming 80% on the first 6%). Once their child's education is complete, they will bump the savings rate to 20%. Also, their annual income is likely to increase, but let's assume it to be constant at $130,000.
At this point, John and Lisa want to make their assumptions as safe and achievable as possible. Even though they will target 10% annual returns, to provide an extra margin of safety, they will calculate the returns on the basis of 7.5%. As you can see below, even with 7.5% returns and an 18% annual savings rate, John and Lisa would accumulate $1.16 million and meet their savings goal.
Table 5A: Investment portfolio growth from Age 55-65
If they're able to grow the same level of savings at a rate of 9% or 10% average annual returns, their ending balance would be much higher, as shown in the table below:
Average Rate of Annual Returns
Ending Balance at 62
We know from the historical perspective that the stock market, over a very long period of time, can comfortably return 9% to 10% annualized returns. However, the big question mark is roughly 8% steady growth over 10 years. The above assumption about growth would be just fine over two or three decades, but over 10 years, it may or may not materialize. The market's ups and downs from year to year can change the outcome. If history is any guide, it can vary greatly depending on how the markets do in the first few years after investment. If there was a big setback right in the first couple of years, it would need time to recapture the losses and come back net positive. However, this is mostly the case when you're invested in broad indexes. But there are strategies that you can build which can protect you from corrections and big drawdowns. We will address such strategies a little later in section II.
For John and Lisa, during their actual retirement years, their strategy looks something like what's presented below. If everything works out according to the plan, they should never run out of money. In fact, as you would see below, at 80 years of age, their portfolio would be roughly double what they started with at age 65 while withdrawing and spending a substantial amount of income. That leaves plenty of scope for margin of error, and in all likelihood, they should never run out of money:
Below is the table that simulates the income and withdrawals from the age of 65-95 years. As you can see below, with 7.5% growth, their balance grows very nicely over the years and provides them a large margin of error or overspending. However, we're going to present two tables with 7.5% and 6% annual growth rates.
Table 6A: Calculation of growth and drawdown with a 7.5% rate
** Cash-reserve ($100,000)
Note: Some rows (from the age group 72-74, 76-79, 81-84, 86-89, 91-94) have been hidden to keep the table size presentable.
Table 6B: Calculation of growth and drawdown with a 6% rate
With a 6% annual growth rate, John and Lisa are still able to grow their capital gradually and are still left with a good amount of cushion over their spending needs. Now, most people would agree that a 6% return over a long period of time is very reasonable to expect, especially if you're doing your homework. Anything less than 6% growth would risk the growth of the portfolio. Basically, we need to earn at least 2% to 3% over and above the rate of inflation.
Now, let's consider another scenario - What if both John and Lisa start withdrawing Social Security benefits at age 67? The overall results will be very similar to what we saw with John drawing at 65 and Lisa at age 70 - however, they would draw on the investment much more during the first couple of years of retirement. If the broader markets were to take a deep dive immediately after they retire, then this option may not be too desirable. Below is an example assuming they get 7% annual returns on their investments. We will see the calculations in the table below:
Table 6C: Calculation of growth and drawdown with a 7.5% rate, SS withdrawals at age 67
The important word here is "consistently." The stock market is anything but consistent. The market never moves in a linear fashion. So, it's important to understand the risks that come with putting all your money in the S&P 500 or any other set of index funds, mainly because in the investment world, 10 years is not a very long time frame, and our portfolio will be subject to the risk of the sequence of returns.
Note: Sequence risk, or sequence of returns risk, is defined as the risk that the stock market crashes early in your retirement or just prior to retirement.
So, what's the alternative? We will admit that there's no perfect alternative. The volatility will be part of any investment. However, there are ways that we can reduce the volatility to a significant extent. Also, it's a proven fact that the lower the volatility, the better will be long-term investment returns as well as consistency in returns. With this view, we will suggest a portfolio with two buckets (but preferably with three buckets) that will greatly reduce the risk of the sequential return and improve the consistency of returns.
The goal of the DGI bucket will be to provide a safe and consistent 4% income in the form of dividends that should increase over time. The DGI stocks also tend to have lower volatility, so they would protect and preserve the capital better than the broader market during a correction. At the same time, the second bucket consisting of a Rotational portfolio will provide the necessary hedge and protect the overall capital, in addition to providing high growth during the good times or bull runs.
If you're a passive investor, you could choose to create a portfolio of dividend ETFs. However, if you're an active investor, you should have a DGI portfolio of individual stocks. Not only would you save the fund fees (however low they may be), but you could buy your positions when they are attractively priced. Also, you would have the flexibility to aim for a higher dividend yield in the range of 4%.
A sample list of 20 DGI stocks with a very attractive dividend yield of over 4% (average) spread over 15 industry segments is presented below. This is not a buy list per se - however, a starting point to do further research and due diligence.
Table 7A: A DGI portfolio of 20 Stocks
Rotational strategies are an essential part of our overall strategy. They not only provide the hedging mechanism (to preserve capital during panics and recessions) but also provide solid growth of capital on a long-term basis. Due to much lower volatility, this portfolio is likely to outperform the S&P 500 over long periods of time. However, it may underperform slightly during the bull runs.
One of the strategies that we like in the current environment is our Bull-and Bear Rotation strategy (this strategy is part of our NPP Portfolio and our Marketplace service).
The strategy is based on eight diverse securities but will hold any two of them at any given time, based on relative positive momentum over the previous three months. Basically, we will select the two top-performing funds. The rotation will be on a monthly basis. The seven securities are:
Please note that the last three are long-term and short-term Treasury funds, which are used as hedging securities (TBF being SHORT long-term Treasury).
Based on the back-testing results, below are CAGR (Cumulative Annual Growth Rates) and maximum Drawdowns since the year 2008 (Jan.2008 until Jun. 13, 2022). The comparison is provided with the S&P 500.
Since Jan. 2008
Since Jan. 2008
Chart 1: Growth comparison for Bull-&-Bear portfolio and S&P500
Note: The above performance results are based on back-testing and provide no guarantee of future results. Also, we do not recommend such a large allocation to this strategy overnight in a lump sum but rather build the position over a period of time.
If you decide to have a large percentage of your assets in rotational strategies, we recommend that you should have at least two rotational strategies to provide reasonable diversification, though it should be determined based on your personal situation in terms of time availability and preferences.
This bucket could mean different things to investors with different goals and stages of life. Retirees or folks who need higher income (less concerned about growth) could invest this sum in a high-income (CEFs, REITs, BDCs) bucket. But please ensure that you choose quality funds. Also, they should be selected from many different sectors and asset classes.
The highly conservative investors who prioritize the conservation of capital above everything else could keep this amount in cash-like securities.
Younger folks or those who are still in the accumulation phase could invest this bucket in high-growth names. However, you should choose these investments rather carefully. There's a difference between growth stocks and speculative ones. One should invest in such stocks over a long period of time rather than in one lump sum. Now, this bucket will not provide much income as such, but the growth of capital should more than compensate in the long run.
Any discussion about stock investments without the associated risks is rather incomplete. Just like with any other strategy, there are certain risks that should be considered while analyzing the above investment strategies and other ideas that were discussed in this article:
We cannot over-emphasize the importance of planning for retirement and investing at an early age. The sooner you start, the easier it would be due to the compounding of investment returns. That said, we believe it's better to be late than never. If you're already 50 years or older, it becomes even more critical to consider various options to see how you could reach your goals in a realistic manner. Even if you have not saved much or just have modest savings by the time you turn 50, there's still ample time to make up for the lost time. However, the more you delay it, the harder the choices will become.
In the second section of the article, we demonstrated a strategy with two buckets that would not only provide a high level of income but would also lower the volatility and drawdowns to a large extent. It will provide growth during the boom years and preserve capital during recessionary times or big corrections. If we invest with a sound strategy that we can live through good times and bad, it is not unrealistic to get 9%-10% annualized returns on your investments.
High Income DIY Portfolios: The primary goal of our "High Income DIY Portfolios" Marketplace service is high income with low risk and preservation of capital. It provides DIY investors with vital information and portfolio/asset allocation strategies to help create stable, long-term passive income with sustainable yields. We believe it's appropriate for income-seeking investors including retirees or near-retirees. We provide ten portfolios: 3 buy-and-hold and 7 Rotational portfolios. This includes two High-Income portfolios, a DGI portfolio, a conservative strategy for 401K accounts, and a few High-Growth portfolios. For more details or a two-week free trial, please click here.
This article was written by
I am an individual investor, an SA Author/Contributor, and manage the “High Income DIY (HIDIY)” SA-Marketplace service. However, I am not a Financial Advisor. I have been investing for the last 25 years and consider myself an experienced investor. I share my experiences on SA by way of writing three or four articles a month as well as my portfolio strategies. You could also visit my website “FinanciallyFreeInvestor.com” for additional information.
I focus on investing in dividend-growing stocks with a long-term horizon. In addition to a DGI portfolio, I manage and invest in a few high-income portfolios as well as some Risk-adjusted Rotation Strategies. I believe "Passive Income" is what makes you 'Financially Free.' My personal goal is to generate at least 60-65% of my retirement income from dividends and the rest from other sources like real estate etc.
My current "long-term" long positions (DGI-dividend-paying) include ABT, ABBV, CI, JNJ, PFE, NVS, NVO, AZN, UNH, CL, CLX, UL, NSRGY, PG, KHC, TSN, ADM, MO, PM, BUD, KO, PEP, EXC, 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, RIO, O, NNN, WPC, TLT.
My High-Income CEF/BDC/REIT positions include:
ARCC, ARDC, GBDC, NRZ, AWF, CHI, DNP, EVT, FFC, GOF, HQH, HTA, IIF, IFN, HYB, JPC, JPS, JRI, LGI, KYN, MAIN, NBB, NLY, OHI, PDI, PCM, PTY, RFI, RNP, RQI, STAG, STK, USA, UTF, UTG, BST, CET, VTR.
In addition to my long-term positions, I use several "Rotational" risk-adjusted portfolios, where positions are traded/rotated on a monthly basis. Besides, at times, I use "Options" to generate income. I am also invested in a small growth-oriented Fin/Tech portfolio (NFLX, PYPL, GOOGL, AAPL, JPM, AMGN, BMY, MSFT, TSLA, MA, V, FB, AMZN, BABA, SQ, ARKK). From time to time, I may also own other stocks for trading purposes, which I do not consider long-term (currently own AVB, MAA, BX, BXMT, CPT, MPW, DAL, DWX, FAGIX, SBUX, RWX, ALC). I may use some experimental portfolios or mimic some portfolios (10-Bagger and Deep Value) from my HIDIY Marketplace service, which are not part of my long-term holdings. Thank you for reading.
Disclosure: I/we have a beneficial long position in the shares of ABT, ABBV, JNJ, PFE, NVS, NVO, UNH, CI, 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, RIO, ARCC, AWF, BST, CET, CHI, DNP, EVT, FFC, GOF, HCP, HQH, HTA, IIF, JPC, JPS, JRI, KYN, MAIN, NBB, NLY, NNN, O, OHI, TLT either through stock ownership, options, or other derivatives. 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. The author is not a financial advisor. 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. The stock portfolios presented here are model portfolios for demonstration purposes.