How Much Do I Need for Retirement? More is Better.

I truly feel for the people who are retiring over the next few years.  This is a terrible time to retire.  With the Federal Reserve holding interest rates down, bank CDs are paying nothing.  There is a bubble in the bond market that will burst when interest rates climb, devastating retirement accounts.  The price of homes a few years back was entirely unrealistic (there was not enough wealth in the country to pay the prices – it was all just made-up money), so people didn’t really lose as much as they think they did, but still the housing prices in some areas has fallen below fair market value so the ability to downgrade your home and use the excess for expenses is not what it used to be.

Traditionally the retirement plan was to save up about 20 times your yearly expenses and then put that money in bank CDs, annuities, and maybe a few bonds and live on the income.  Because your house was paid off and your kids were out of the house, a couple could live very comfortably on $50,000 per year, so $1 million dollars was the goal.  Today bank CDs, however, are paying around 1%, bonds are inflated so they are not paying what they normally do and there is a lot of risk of a decline in value.  Annuity rates track other rates, so there is not that much income there either.

For those retiring now with only $1 million or less, the only answer is to make do as you can.  Work as long as you can and build up all the cash you can.  Maybe consider a second career or make money selling things on eBay or doing freelance work.  Cut down expenses as much as possible.  Hold your nose and a use bank CDs and a few bonds for income, but realize there is a good chance the value of the bonds will decline sometime in the not-to-distant future when interest rates increase.  Maybe also buy a few high quality dividend paying stocks since these will give you both a (small) income and there is some chance at appreciation.  If your home is paid for, don’t take out any loans.  If you need cash from your house, sell it and buy something smaller or move to an apartment – reverse mortgages will suck most of your equity away in fees and interest.

This should be a lesson though for those who are younger and still in your earning years.  The more money you have at retirement, the more opportunities you have.  This is because you can afford to take more risks.  While bank CDs have been earning less than 1%, stocks have been on a tear during the last several years.  The S&P500 returned more than 15% in three of the last four years and returned 26% in 2009.  If you had a $10 million investment in the S&P500 you would have earned $2.6 million in 2009, $1.5 million in 2010, $211,000 in 2012, and $1.6 million in 2012.  Compare this with only earning $100,000 per year in a bank CD paying 1% through the period.

So why shouldn’t the person with $1 million just invest in the S&P500?  Well, in 2008 it declined by 37%.  This is an extraordinary event that may only happen every 20 or 30 years, but such a loss for a $1 million account would be devastating, bringing the value down to only $640,000.  The person with $10 million would have lost $3.6 million, bringing the value down to $6.4 million, but that would still have been plenty of money to cover expenses and wait for the market to recover.  Normally in years like 2008 when there is a big drop the next year sees a big recovery.  If you cannot afford to take the risk, however, because you need every dollar to live on, you won’t be able to wait.

So, while you may only need about $1 million to retire under normal circumstances, having quite a bit more will allow you to take greater risks and get greater returns.  You should be putting at least 15% towards your retirement when you are young (this is before any company match or other bonus, because those matches could very well go away) and at least 10% when you are older if you have already built up a good investment savings.  Hopefully by the time you are in your late 50’s you will have saved so much it won’t matter if you contribute to your retirement accounts or not.

What are your plans for retirement?  Have your savings recovered after the 2008 crash?  Where is your ideal retirement place?

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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