What You Must Know Before Investing
Every “retirement calculator” I’ve come across always begins with you assuming an investment rate of return you either want to earn or think you can earn.
For anyone approaching their retirement transition, this puts the cart before the horse. It gets many dedicated savers into trouble and can lead to unnecessary confusion and anxiety.
Once you’re past the first steps in The Relaxing Retirement Formula outlined in my book, and you know how dependent you are on your retirement portfolio, the next question is, “Assuming historic rates of inflation, what investment rate of return do I need to earn to make my retirement portfolio last?”
I’m now in my 36th year of helping coach individuals and couples through this challenging retirement transition, and I have yet to meet one couple who knew the investment rate of return they must earn for their retirement portfolio to last beyond their life expectancy.
This rate is not chosen arbitrarily. It’s the investment rate of return that allows your retirement portfolio to remain intact year after year while you withdraw the increasing level of funds you need to support your chosen lifestyle and keep pace with inflation.
The rate of return is different for everyone, so there are no accurate “rules of thumb.”
Why This Rate Is Different for Everyone
To illustrate, let’s revisit our two fictitious couples, Mike and Mary, and Ron and Rose, all aged 62. To keep it simple using round numbers, assume each couple has:
- $2,000,000 in their retirement portfolio
- the same Social Security retirement income of $4,000 per month and
- the same monthly pensions of $3,000
Beyond that, here’s what else we know about them:
Mike and Mary have no mortgage or home equity line of credit, and they have recently completed many major upgrades to their home, i.e. a new roof, indoor and outdoor paint, a new furnace, new kitchen countertops and cabinets, and new bathrooms. They purchased new cars with cash in the last two years which they plan to drive for 10 years.
Ron and Rose still have $300,000 outstanding on a second mortgage they used to pay for their kids’ college tuition, weddings, cars, and a condo in Florida they bought a few years ago. They both drive high-end cars which they replace every three years. And, while their home is very nice, after 26 years, it is starting to look “tired” and will need significant upgrades in the next two years.
Ron and Rose are clearly more dependent on their retirement portfolio than Mike and Mary, meaning they need to withdraw a lot more money each month to support their more expensive lifestyle, i.e. $9,500 per month vs. $6,500 per month.
For Ron and Rose’s retirement portfolio to remain intact for the rest of their lives, it needs to grow faster so they don’t run out of money.
- 4.0% per year: Mike and Mary’s minimum investment rate of return needed
- 7.2% per year: Ron and Rose’s minimum investment rate of return needed
As you might imagine, there is a significant difference between earning 4.0% per year and 7.2% per year! This is why generic “rules of thumb” like 100 minus your age are potentially dangerous at this stage in your life. It’s impossible for the “100 minus your age” rule of thumb to be the correct formula for Mike and Mary and Ron and Rose.
Because of this, Ron and Rose’s strategy for their retirement portfolio has to be very different than Mike and Mary’s!
When you’re rapidly approaching or have reached the stage where the money you’ve saved must now support you for the rest of your life, when you’re dependent on your retirement portfolio to “live” as opposed to receiving a paycheck from work, you have to think differently about how you invest.
Investing without first knowing the real rate of return you must earn is like having invasive surgery without being thoroughly diagnosed first.
It doesn’t make any sense.
In the next installment of this series, we’ll discuss the strategic and psychological benefits of understanding what portion of your retirement portfolio you should not invest as you prepare for and make your retirement transition. Stay tuned.
*Please Note: Limitations: The above is a hypothetical scenario – not involving an actual Savant client. It illustrates the hypothetical experience of a fictitious couple based on a scenario that an actual couple might experience. Keeping in mind that no two individuals, situations, or experiences are exactly alike, the above should not to be construed as an endorsement of Savant by any of its past or current clients.
Jack Phelps
Financial Advisor / Managing Director