By Tony Kendzior, July 1, 2016
I’m talking about all of us mortals and what we need to pay our bills and live our lives. What follows are my thoughts and some hints to help you answer this question. It’s intended to help you define your financial future with the certain knowledge that in our society, more money is almost always better than less money.
And know this; there may not be a right answer. But to find even a wrong answer, you need to explore all the variables if you are to have any chance of achieving the best financial future possible for you and your family members. Or you can depend on luck.
Basically, it’s a hard question. And each of us will come up with a different answer, or perhaps a whole series of answers. They may happen if your ‘pile of money’ comes directly from your time and effort, or from somewhere else. Did you win the lottery, or perhaps inherit a substantial sum from someone? If you did, that’s fine, but it doesn’t answer the questions associated with how long that money will last.
It’s also likely the answer(s) will change along the way. A good answer from you today will probably be different from the answer(s) you come up with several years from now. And your answers will assuredly be very different from my answers when I ask myself the same question. The temptation is to simply blurt out a large number and then hope it comes out in your favor.
Here’s a problem though. HOPE is not an effective strategy when it comes to accumulating money for retirement.
As you read this today, understand all this effort has an underlying truth. Which is that none of us has a contract with God to be here tomorrow, much less at some point in the future when a comfortable retirement is among our primary goals. At that point, our ability to work and create income may be severely limited. So the objective is to have ENOUGH. Which rounds back to the primary question, How Much Money IS Enough?
Here are some of the variables to consider and what they mean:
1. What do YOU think is enough money to get you through a year today? It’s largely determined by your present standard of living and your acceptance that if you live, your retirement is in the future. This is the third and final phase of our lives. You may be retired already, either by choice or not, and the question HOW MUCH IS ENOUGH? may be rearing its ugly head.
2. The next question is how long will you live, and will you leave family members behind who will be dependent on your pile of money. How much is enough for them? If your grandparents lived into their late 80’s or even into their 90’s, it follows that you might also. If your plan, whether realistic or not, is to retire at age 62, then it follows you should have enough money saved to live another 30 years or more. Either that of have a way to create additional income.
3. What exactly is “retirement”? Financial planners identify three principal periods in a persons life. These are:
a. Childhood – when you are young and growing toward adulthood and the basic necessities of life are provided for you by others.
b. Adulthood – when you transition to a point where the basic necessities of life are provided by your energy and efforts and you establish yourself as a functioning adult in society.
c. Retirement – when you transition from working for money to having money work for you. For some of us these days, it might mean working at Walmart as a greeter. Not exciting, but it might mean the difference between having enough and not having enough.
4. How do you respond to the threats posed by existential risks? This is sort of a psychological profile question, but it resonates with those who understand there are threats out there, some of which can be safely ignored and others that need to be dealt with. How much money in any given year are you prepared to ‘lose’?
Among the risks we deal with are car insurance and fire insurance or hurricane insurance to protect our homes. If nothing bad happens, we’ve spent some money to give us peace of mind. But threats exists out there that fall into what I call the “Lloyd’s of London” category; unlikely, but hugely disruptive.
Some of us freak out and lose sleep over unlikely threats while others find it expedient to ignore them. This is not to say either way is right or wrong, but how do you respond to this? Your challenge, our challenge, is to identify some of these threats so you can categorize them and either deal with them or ignore them. The danger is realizing too late that one of these threats existed and you didn’t position yourself properly to offset the damage. Invariably they come from an unexpected direction.
5. Most of us will need to draw money from our accounts to support our standard of living, and to pay bills. In a low interest world, which is what we have today, withdrawing at a low interest rate implies money will last longer. What will happen to interest rates in the future? What happens if we live too long?
If interest rates start to reverse the downward trend of the past 35 years, and we have to adjust to living in a world with ever rising interest rates, how will that affect our investments? If you are now 65, and male, the Social Security table says you can expect another 17.75 years. This is an average; half of us will live longer than that. How much money will you need?
Most people attempt to grow their ‘pile of money’ for retirement using traditional investment options like an IRA, or a 401k or a 403b, or several others with obscure tax-code numbers. These are taxed when you take the money out. Then there are options where you pay your income taxes before you put the money in. Whatever you use, at some point you will reach into these buckets of money and withdraw what you need to survive and thrive.
6. We financial professionals argue about how much can you can withdraw each year from your “pile of money” and not have it run out.
a. How much do you need from your portfolio each year? To figure this out, compare your total income from Social Security and other sources to what it will cost to live your desired lifestyle each year. The difference is what you’ll need to pull from your savings. Prevailing wisdom says you should try to keep your annual withdrawals to 4% of the total account balance each year. But even 4% could be too high, depending on how you invest the money. Or it might mean you die at 85 with several million dollars in the bank. It’s now too late to realize you could have spent several months in the south of France every year and still not run out of money.
b. How does your portfolio need to be invested to support your withdrawal needs? On one hand, if you have lots of money, you may only have to take the minimums. If so, you can probably afford to be more conservative with your investment approach. On the other hand, if you need some portfolio growth to make the accounts last given your planned withdrawal rate, a more aggressive investment approach may be needed. The key is to try to find the right balance between what you need and what’s prudent from an investment standpoint. And ask yourself when you plan to die! Damn, this is difficult.
c. Are you comfortable taking the needed level of risk? It’s possible your number crunching could indicate you need to take more risk in order to support your withdrawal needs. If you’re not comfortable with the risk you need to take, or if taking it wouldn’t be prudent, you may need to cut your desired lifestyle.
7. Some of us take an different approach and build our wealth with real estate. Historically, the investment return on real estate exceeds the investment return of stocks and bonds. The reason for this is real estate is less liquid. If you have $500,000 worth of real estate and you suddenly need $50,000, you may not be able to sell a piece of property quickly enough. You might, however, go to your favorite bank and borrow the $50,000 using the real estate as collateral, but that implies you may have to sell the property anyway in order to repay the bank.
Owning real estate can be a full time job. If you really love the idea, and find satisfaction in dealing with property issues, then more power to you. But at some point, it makes sense to begin the transition to other forms of investments that offer more flexibility as you live out the remaining years of your life.
8. Social Security is a primary source of income for many people in retirement. At first glance, you get what you get with little opportunity to modify the outcome. But there are lots of variables that need to be thought out early on.
A simple way to describe the various options results in either one of two possible outcomes; you either get small checks for a longer period of time or you get larger checks for a shorter period of time. This happens as a result of having a total of 92 months from which to choose to start receiving our Social Security benefits.
Beyond choosing which month to start your benefits are the dozens of options that result from different earnings histories, different ages if you have a spouse, are you widowed or have an ex-spouse whose earnings and age create new options for you. The myriad options are far too complex to get into in this discussion today. Suffice to say, it’s not black and white and depending on which month you choose, it may be enough or it may not be.
At the end of this particular question is another stark question that you cannot answer: “When will I die?” This is relevant because whether you choose the small checks for a longer period or larger checks for a shorter period, both of them stop when you die. If you are single and/or have no children, does it matter? Maybe.
9. Defined Benefit pension plans put in place years ago are contracts that provide a monthly retirement income to millions of Americans. Less so now than in years past, but they exist. If this is you, then you should know that across the country, they are largely underfunded. Will they run out of money before you die? Probably not, but you still have questions to answer when you sign up to start taking your pension. Do you have a spouse? If so, how old is that spouse relative to you? Do you care if the pension benefit stops if you are the one to die first? If you do, what percentage of your benefit will flow to your spouse? Does it have an inflation component?
At this point I’m going to stop talking. My hope and expectation is that you will now have a better understanding of the framework you need to keep in mind as you wrestle with what it takes to achieve the financial freedom you’re going to want to have when you retire.
Good luck with your quest. Don’t ever hesitate to reach out to me for clarification or an in-depth discussion of your particular circumstances.