In my free time I regularly read Yahoo finance or the CNN Money articles related to personal finance and retirement. People are told that they need to save as much as possible for retirement, because they will be spending somewhat close to 75% of their pre-retirement incomes per year. In addition to that most so called financial guru’s claim that Social Security and Medicare will be either bankrupt or providing only enough coverage for the elderly that would allow them to enjoy cat food and insufficient health care in retirement. In order for people to be able to retire comfortably in those gloomy future years, they have to save as much as possible and invest it all in the stock market, in order to generate one or two million at the time of their retirement, which would then allow them to withdraw fund during their non-working years.
I generally disagree with these articles, since they are way too general. They are written with the intend to target as many people as possible. But they are far away from the truth.
In my opinion, it is important to have paid in full your primary residence at the time of your retirement. Once this is done, the income requirements are much lower than during your working years. Most financial experts recommend that the annual mortgage payment for a primary residence should not exceed 35%-40% of the family’s income. If you are currently spending 30% on your income in order to be able to pay off your house by the time you retire, then you will be able to live on 30% less income during retirement.
In addition to that, if dividend and capital gains income continues to get a preferential tax treatment, you will need less investment income for each dollar of job income that the investment income is replacing. The best thing of investment income is that you don’t have to pay Social Security and Medicare on it.
Finally, in order to determine your income needs in retirement, you should subtract the amount of money which you normally contribute to your salary every pay period. I wouldn’t expect that you will need to save for retirement, in retirement. If you contribute 10% of your salary to a 401K plan for example, then you need to subtract that percentage from your income needs.
A potential wild card that could possibly derail one’s retirement is the rising costs of healthcare. We are constantly reminded how healthcare costs are rising exponentially and how they would become even more expensive in the future. I do think however that in the future health costs increases will not rise more than the rate of inflation, after stricter insurance reimbursement policies require health management organizations to be more selective in their billing to patients and the procedures that are recommended.
After one’s retirement needs have been estimated, it is a good idea to create an investment plan, which would help you in your quest to reach your goals. A solid mix of dividend stocks and some bonds would be a good place to start. Don’t have time to play a stock picker- then select a mix of index funds. Then set it up on autopilot by investing a fixed amount from your paycheck every pay period.
Relevant Articles:
- Determining Withdrawal Rates Using Historical Data
- Back test Results of one Rule of Thumb
- The case for dividend investing in retirement
- Ten Things to Know About Dividends:
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I think the "gurus" (cough!) are erring on the side of caution. However, you make mention of the health care wild card. Think about how much health care costs and how much more you require as you age. I've read something recently that purports you really need close to 100% of your current income because your overall needs don't decrease, they shift.
ReplyDeleteI would guess the median salary of my friends and family is about 50K. If you sock away $1,000,000, you can probably live on the interest alone assuming the median risk free rate is ~5% over the course of your retirement. You can draw a little more in the lower rate stretches and replace a little during higher rate days. And of course, you can't take it with you, so why not take a little extra from the principal each after you've gotten a handle on the wildcards.
And all of this assumes no social security benefits. Because honestly, can you really rely on that absolutely being there? I wouldn't bank on it.
My two cents.
I AM retired, and I can say this for sure: All estimates of the nest egg needed to retire, that are expressed as a percentage of your final income, are waaaay too general to be of use. You have to plan for your own retirement by building, from scratch, a retirement budget.
ReplyDeleteSome costs go down in retirement: No mortgage (if you've paid off your house), no 401(k) contribution, less spending on clothes, less spending on commuting, etc.
Some costs may go up: You may spend more on travel and leisure activities, healthcare costs may go up, and the like.
The answer for each individual (or couple) is different. The "70% of final income" type answers are too general. At the end of your worklife, you may not have been spending anywhere near your total income to live...you may have been socking it away (for retirement), or paying down your mortgage or other debt.
Create your own budget, based on both your needs and desires for the kind of retirement you want.
Bill and David,
ReplyDeleteThanks a lot for your input. I am simply trying to view the amount of money soaked for retirement question form several angles. You might enjoy those articles as well:
http://dividendgrowth.blogspot.com/2008/08/how-much-money-do-you-really-need-to.html
http://dividendgrowth.blogspot.com/2008/07/determining-withdrawal-rates-using.html
http://dividendgrowth.blogspot.com/2008/03/case-for-dividend-investing-in.html
"I do think however that in the future health costs increases will not rise more than the rate of inflation, after stricter insurance reimbursement policies require health management organizations to be more selective in their billing to patients and the procedures that are recommended."
ReplyDeleteI found this comment on health care costs to be somewhat vague, and doesn't really make sense to me. Can you expand a bit?
Are you thinking that the HMOs are not insurance companies? Who is setting these "stricter policies" and which group is following these policies?... doctors?...hospitals?
Even if your mortgage is payed off, don't forget about property taxes and costs of maintaining a home (or in the case of a condo, HOA fees) as well as home owner's insurance.
ReplyDeleteI agree with David - 70% rule is way too general. I will also add that retirement calculators are unnecessarily scientific because nearly all approaches agree you can spend roughly 4% of assets safely.(The math is too complicated for a comment but is explained in How Much Money Do I Need For Retirement for those that are interested. Since you can spend 4% of assets merely figure your first year budget and multiply times 25 to estimate required retirement savings (Rule of 25). This must be adjusted for inflation. Additionally, you have a huge advantage being focused on dividend growth investing because that takes care of the rarely discussed problem of increasing longevity. The simplest plan is just to build savings until your dividends exceed your spending (the cash flow retirement plan). Limit your spending increases to your dividend increases and it is pretty hard to go wrong.
ReplyDeleteHope that helps...