Why Four is Better than One – How Much Should You Be Saving for Retirement?

In Retirement Goals for Life I discussed what point individuals should be at during each stage of their lives to meet a retirement goal of about $4 million in today’s dollars.  Many people would consider $1 Million to be perfectly adequate since, by the conventional logic of taking out 4% the first year and then indexing for inflation, that would provide a yearly income of $40,000.  If you have the home paid off and no other large expenses except perhaps some medical bills, that would be enough to live a comfortable retirement.  One would think that saving additional funds would not be wiorth the effort.

The issue with only having $1 Million, however, is that you are not able to take on any risk to gain a greater reward.  You are pretty much trapped in getting an annuity or keeping your money in bank CDs because if you invest in anything else and it has a bad year like 2008 or even 2000, you would not have enough wealth remaining to generate the income you needed.  You would not be able to just wait it out for a few years because you would need that $40,000 per year to live on, so you’d end up depleting your retirement savings very rapidly.

If you had $4 Million, however, you could still keep $1 million in CDs or in an annuity and invest the other $3 Million.  On years when the market did well you could sell some shares, build up your cash reserves, and maybe use some of the money for travel or other luxuries.  On years when it didn’t you could just live on the cash you had accumulated and be no worse off than someone who just had $1 Million in savings.

If you had enough money you could just virtually invest it all.  For example, if you had $10 Million, you could keep everything except maybe $100,000 invested.  The $100,000 would be less for safety than for convenience – not needing to sell shares when you wanted to buy things.  Even if we went through the Great Depression again where stocks dropped an astounding 90% (imagine the Dow Jones Industrial Average dropping to 1400 today!) you would still have the $1 Million in reserves.  Given that the Great Depression only happened once in our history, chances are the worse you might see is a drop to $6 Million or so, and in most cases your accounts would be back to $9 or $10 Million again within a year.  It is very likely that you would see you $10 Million grow to $20 Million while you were retired.

Note that discussions so far have focused only on equities (stocks) and cash.  I’ve not even discussed income producing assets like bonds that most advisors recommend.  The rule-of-thumb is to “keep your age” in income producing assets which are considered safer than stocks.  This would be corporate bonds and treasuries, although you could throw in REITs and dividend paying stocks like utilities.  For example, if you were 60 you would keep 60% of your assets in income producing assetsa nd 40% in growth assets.

The truth is, while having a diversified portfolio can reduce the levels of fluctuations, it is probably safer to have mainly cash assets like CDs and annuities (and spreading these out to multiple banks) for expenses that will occur within five years than to hold bonds.  The reason is that while bonds do have the advantage of paying an income even when equities are falling or just sitting there, they are still tied to corporations.  When corporations are having problems they do default on bonds, leaving the holder with pennies on the dollar if that.

Even US Treasuries are looking more suspect everyday with our growing debt and lack of resolve to do anything about it.  Eventually (probably within five years) the interest payments on the US debt will grow so large that it will be a choice between paying the interest and paying for programs like Obamacare, Social Security, and Medicare.  Given the lack of resolve to cut anything, either by the public or the Representatives they elect, it is likely there will be a default on US debt.  This was been telegraphed by the downgrades of US debt a couple of years ago when it became clear that no resolve to tackle the issue was present in Congress or at the White House.

That said, if you have substantially more than $1 Million, you could place some of your money in bonds and other income producing assets since, once again, you would have the ability to suffer some losses without putting yourself in dire straights.  The advantage of using bonds, besides the diversification they provide, is that because they generate income you can generate the money for living expenses without selling assets and incurring the brokerage commissions.

A disadvantage of bonds and other income securities is that you have income which at times has been taxed at higher rates than capital gains.  For this reason it would be a good idea to keep some of your income producing assets in tax sheltered accounts like IRAs to reduce your yearly tax bill and allow these assets to compound.  Of course, that prevents you from using the income from those assets to pay for expenses unless you withdraw it from the IRA and pay the tax bills; therefore, probably the best thing to do is to keep enough income producing assets that pay dividends (not interest) in taxable accounts to pay for current expenses, since the tax rate would generally be lower on dividends than ordinary income rates, and then keep other income assets that pay interest (like bonds) in IRA accounts.  This would allow the interest from them to compound before being taxed.  Also, if you need to take a withdraw from the IRA each year – because you need the money or have reached the age when it is mandated – you could hold enough income producing assets to produce the needed income in the IRA and avoid selling your other stocks until ready.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

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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