Funny thing. Pretty much since I started working a real job, paid off my car, and decided that I would never have a car payment again (or a credit card interest payment, ever), I started projecting how much our net worth would be at different stages of our lives. I had always assumed that I would work until I was about 70, and that long work career, combined with regular investing and living a comfortable but financially responsible lifestyle that grew with time but always allowed a substantial majority of the income from our investments to compound, caused me to project that we would have no issues with money by the time we retired. Despite a terrible ten years or so in the stock market after I first made those projections (right before the dot-com bubble burst, the housing bubble burst, and then the multiple years of slow growth ensued), we are tracking well with my original projections. Depending on the rate of return I assume over the next 25 years, I think we’ll end up somewhere between maybe four times and fifteen times what I would consider the bare minimum needed for our minimum income needs in retirement. Probably closer to the former, but if the stock market does great and we see returns at the top of the possible range, the latter.
But then I started playing around on the Vanguard website the other night. They have a neat tool that runs a whole series of Monte Carlo simulations for you. (In a Monte Carlo simulation, you run a whole series of calculations to determine the range of possibilities of where you could end up.) These simulations take a mix of cash, stocks, and bonds and run simulations based on random but historically accurate returns for each of these categories and project where you’ll be twenty, thirty, or forty years out after retirement under different market conditions. The purpose of the simulator is to show how much income you’ll be able to spend and have a good chance of making it all the way through retirement without running out. For example, if you expect to have $1 M at retirement and pick a portfolio of 50% bonds, 40% stocks, and 10% cash, you may find that you’ll make it through a retirement of 30 years without running out of money maybe 70% of the time. It is also meant to show the advantages of adding bonds and cash to your portfolio since your risk of running out of money will generally go way up if you stay in all stocks and spend a healthy amount of cash each year if you start with a modest nest egg at retirement.
If you start with substantially more than you need, and plan to spend an amount that is very modest compared with the size of the portfolio (less than 1% per year, for example), a funny thing happens. Even in the all stock portfolio, your chances of making it all the way through a 30 year retirement without running out of money can become almost certain. Even in the worst of circumstances where the stock market does terrible a lot of the time, you can still expect to die with a few hundred thousand dollars net worth because you started out so far ahead of the game.
What is really odd, however, are the best scenarios – the ones where the economy does really well, like it did back in the 1980’s and 1990’s, and everything just works out really well. In that case, because you’re entirely invested in stocks, you can see your net worth grow from the simply comfortably wealthy into the leagues of unreal wealth – $100 M, $300 M, even the ultimate level, a billion dollars! Imagine joining that elite circle with Warren Buffett, Donald Trump, and Bill Gates. OK – so I still wouldn’t be quite at their level, and they still wouldn’t return my calls. And they would be like trillionaires by then. And they’d all be dead by then. And I’d be the next day. But still!
Standing where I am today, that hardly seems possible. But then again, starting out with a couple of thousand dollars in an emergency fund when we were in our twenties, I could not image being where I am twenty years later even though the math said it would happen if the economy continued to perform as it had for the last couple of hundred years. The power of compounding at stock market returns, which can average anywhere between about ten and twenty percent annualized over a given fifteen-year period, does not stop just because you’re retired. That thirty year period between retirement and death is no different from the one between twenty-five and fifty-five, provided you don’t withdraw funds too rapidly and allow your investments to continue to grow.
So will we die as billionaires in fifty-five years? Probably not. But we’ll probably leave a significant inheritance and make a sizable donation to some cause unless the markets do really badly between now and then. Historically badly. Still, it shows the advantage of working to retire with more than just the bare minimum, since then you can let your money continue to grow in the stock market rather than needing to convert it all to cash and bonds, or worse – give it to some insurance company to get an annuity. So here’s to all the potential future billionaires out there who just look like middle-class workers with older cars right now.
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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.