When can I retire?

This one’s a biggie.  Actually I was going to do a post entitled “How much do I need to retire?”  However, in order to answer that huge question you need to answer three sub-questions:

  1. How much will I spend in retirement?
  2. How much will I save during my working years?
  3. When will I retire?

Once you answer those three questions, I think you can have a pretty good idea of what your number needs to be and ultimately when you can pull the ripcord on retiring.  So with that said, I guess I’m kicking off a three-part series.

 

Determining the amount you will spend in retirement is a really hard thing to do.  That’s not really comforting given that your monthly spending has a huge impact, as you would expect, on the amount you need to retire with.  So for example, if you plan on spending $5000 per month in retirement (all numbers are going to be in today’s dollars unless otherwise noted), you would need about $1.3 million when you retire*.  However, if you increased that monthly spending to $6000 then your nestegg would need to be $1.5 million.  Push the monthly number up to $10,000 and your nestegg needs to be $2.5 million.  Obviously, that monthly number is incredibly important in your planning.  So clearly when you start figuring out your financial plan, you need to have a decent idea of what you’re going to spend in retirement.

Unfortunately, this is no easy task.  There are a couple approaches you can take, all of which leave something to be desired.

  1. Percentage of income: The most common approach you hear is to take your current income, take a percentage of it (often people suggest 80%) and plan on spending that in retirement.  I DESPISE this approach for a few reasons.  Take two identical couples, the Foxes and the Grizzlys, both of whom make the same amount of money, let’s say $150,000.  According to that formula we should take $150,000 and multiply it by 80% to get $120,000, and that’s what we should plan on spending in retirement.  That means both families need a nestegg of about $2.5 million

First, I think when you use this approach, you get a number that is way too high.  Very few families are spending 80% of their salary.  Taxes are probably 20-30%; savings in 401k’s and other accounts are a significant chunk; spending on the kids is 10-20%; a mortgage is probably your biggest expense.  All that should go away in retirement.  I bet the average $150,000-income family is spending much, MUCH less than $120,000 right now, and it seems that should go down in retirement, not up.  Am I right?

Second, it assumes all families are the same.  Let’s say that Fox family is pretty thrifty while the Grizzly family is pretty extravagant.  We’re both making $150,000 but the Grizzleys are going to need a much larger nestegg than the Foxes.  Clearly this approach sucks.

  1. What are you spending now: With another approach, you could take what you’re spending right now as a baseline for what you’ll spend in retirement.  The positive of this is that it takes your personality into account—if you’re an extravagant person now, it seems likely you’ll be extravagant in retirement; conversely if you’re thrifty now you would think that would translate during retirement.

Of course, the huge miss is that your spending changes in pretty major ways at different stages of your life.  The Fox family has expenses of about $8500 per month right now, but that includes a mortgage ($2200), preschool for the cubs ($700), saving for Lil’ and Mini Foxes’ college educations ($1000).  All those will go away in our retirement, so that off the top brings down our expenses to $4600.  And that doesn’t take into account how our expenses will change for the less expensive (down-sizing our house, not driving to work every day, etc.) and for the more expensive (more vacations, more leisure activities, etc.).  Wonderful, our expenses could range from $3000 to $8000.  That means our nest egg needs to be anywhere between $800,000 and $2,000,000.  That’s not a lot of help.

  1. Bottom’s up: You could build on approach #2 and look at your current expenditures, and then try to project what future ones will be.  Right now the Foxes spend about $1,000 on groceries and $200 at restaurants per month.  In retirement we’ll only have two mouths to feed instead of four, but we’ll probably enjoy eating out more: maybe we assume groceries go to $600 and restaurants go to $300.  Maybe we’re right, maybe we’re wrong, but at least we’re trying to get a more accurate number.

The problem with this comes in for expenses you have no idea about.  Are we going to be bitten by the travel bug?  Will that cost $400 per month or $1000 per month?  Tough to say.  Also, you have some real unknowns like what will happen with health insurance, or will Social Security be there for us?  Of all the approaches, I think this one gets you the closest and takes into account your individual tastes, but it is also the hardest to do because you’re trying to predict both what you’re tastes will be many years from now and how much that will cost.

  1. Look at the data: The last approach you can take is to look at the data.  This, combined with #3 is my preferred approach.  In the US we’re fortunate that the Bureau of Labor and Statistics publishes a huge report that looks at individuals expenditures.  This is a treasure trove for trying to figure out what is “average” and then using #3 to determine if you should be above or below average.  It slices spending along almost any dimension you want—age, gender, race, age, geography, number of family members, education, etc.—and then it breaks down the spending into categories like housing, food, apparel, leisure, healthcare, entertainment, etc.  Of course, these are broad averages and your individual circumstances will vary, but it does provide tremendous insight.

So for example, the average family spends $51,422 per year, and if you look at that by income (I know, that’s approach #1, and I don’t necessarily like doing this), you get the following table:

Income

Expenses

Less than $70,000

$34,679 (108% of income)

$70,000 to $80,000

$59,984 (80%)

$80,000 to $100,000

$67,418 (76%)

$100,000 to $120,000

$77,966 (72%)

$120,000 to $150,000

$89,521 (68%)

More than $150,000

$129,211 (51%)

 

A couple interesting things jump out here.  First, as your income goes up, your expenditures also go up but not at the same rate (you go from spending 80% of your income to 68% of your income), so this means approach #1 doesn’t work.  Second, spending $10,000 per month is a lot.  Only the very wealthiest Americans spend that much money, and keep in mind those are people making $150,000 per year or $150 million per year.  More on this in a minute.

Another really interesting table is when you look at expenses by age, especially in our golden years:

Age

Expenses

Relative to 45-54

35-44

$58,069

-6%

45-54

$62,103

55-64

$55,636

-10%

65-74

$45,968

-26%

75 and older

$33,530

-46%

 

Our spending peaks in the 45-54 age range.  That makes sense—kids are teenagers which is when they’re most expensive and we’re making more money so we want to start enjoying the finer things in life.  But after that spending starts to fall precipitously.  The kids leave the house, maybe we downsize the house, we don’t commute to work and don’t need work clothes, etc.  By the time we’re in our mid-70s we’re spending half as much as we were in our late 40s/early 50s.  Incidentally, it’s probably in our late 40s/early 50s that we’re starting to budget seriously for retirement, so we’re working off an inflated expense mindset.

You never want to use anecdotes, but all these numbers seem about right.  My grandparents are in their 80s and they hardly spend any money.  They have the means (he gets a military pension) so it’s not like they’re impoverished, but they are just at an age where they take it easy.  They don’t travel, they own a car but drive very little so it’ll last forever, and they don’t eat too much.

 

Add it all up

I think the winning combination is using #4 as a foundation and then adjusting it with the particular things you know about yourself from #2 and #3.  A super-posh lifestyle would be spending $129,211 per year.  Lady Fox and I aren’t super posh—let’s say we’re moderately posh so we’re more in the $77,507 per year category despite the fact that our current income is much higher (see, it shows that income and spending aren’t inextricably linked).  $78k per year is about $6,500 per month.  If you take our expenses now ($8,500 per month) and strip out the ones we know go away when we retire we’re down to $4,600.  Assuming we spend $6,500 per month implies we greatly increase expenses like leisure, vacation, etc.; also, we’re planning on increased healthcare expenses.  That seems reasonable, maybe even a little too high.  But let’s go with it.  If we assume spending $6,500 per month every month during a 30-year retirement, we’d need a $1.6 million nestegg.

But then remember that as we get older our expenses will go down.  They’ll peak at $6500 per month, but when we hit 55-64 they’ll go down about 10% ($5900), when we hit 65-74 they’ll go down about 26% ($4800), and after 75 they’ll go down about 46% ($3500).  If you take that into account instead of $1.6 million for a nestegg, we’ll only need $1.1 million.  That’s a pretty huge difference just for taking into account the “natural” curbing of spending that happens when we age.

 

So there you go, the Fox family will probably be spending in the $6500 per month range and that will slowly fall to $3500 per month when our tails are fully gray.  As I said at the beginning of this post, when trying to answer the larger question—How much do I need to retire?—this is just the first step.  Make sure you check back Thursday for my post on how to estimate the other two pieces for your retirement picture—how much you’re saving while working and when you’ll need to retire.

 

*All calculations unless otherwise noted assume: 30 year retirement, 3% inflation, 6% investment return.

Your Own Little Vegas

“Las Vegas wasn’t built on winners”

In a lot of ways investing in the stock market is like gambling in Las Vegas: the whole premise is based on uncertainty, you can win a lot or lose a lot, it can be really exciting, and there are suckers bets that are tempting but should definitely be avoided.

And then there is one huge difference: the “house advantage” works against you when you gamble in Las Vegas, but works to your huge advantage as an investor.  In Las Vegas, the odds are decidedly in the house’s favor.  Over the long run, it is a mathematical certainty that the house will win and you will lose.  After a single hand or roll of the dice, you might be up, maybe even up big.  But if you play long enough the house’s advantage will dominate and the casino will take your money.

However, as an investor, you are the “house”.   In investing there will be ups and downs, but over the long term the investor always comes out ahead.  Since 1929 there has never been a 30-year period where stocks ended lower than when they started.  Go ahead and read that sentence again.  If you invest, properly diversify, and stay steady with your convictions that you will come out ahead, you will make money in the stock market.  Since 1929 there have been some brutal times, some lasting 10 or even 20 years (stocks were 3% lower in April 1949 than they were in April 1929; stocks were 2% lower in November 1978 than they were in November 1968).  Yet in each of those examples and every other, if you hold out long enough, you’ll make money.  Basically, you are the house in the game of investing.

Since we know you’re the house, what are the lessons we can learn from the casinos in Las Vegas that have allowed them to make so much money?  First, offer free drinks and $5 prime rib dinners to your house guests.  Just kidding.

 

Stay in it for the long haul

There will be some days or weeks or maybe even months where a casino loses money.  When that happens and the pit boss says, “Wow, we’re down $200,000 on the craps tables this week,” casinos don’t shut down the craps tables.  They certainly don’t say “hey, we tried having craps tables, but it didn’t work so let’s stop having craps in our casino.”  On the contrary, they keep them open knowing that the more people play craps (or any other casino game), over the long run the casinos will make money.  Sometimes the long run will be a day but sometimes it will be much longer.

In stock investing, as we mentioned above, the long run could be years or even decades, but if you keep your crap tables open, if you keep investing in the stock market over a long investing career, you will make money.

 

Smaller bets are better

While they don’t say it, casinos want smaller more frequent bets.  Imagine two gamblers playing roulette: Mr One Bet and Mr Many Bets.  Both are going to gamble $100, but Mr One Bet is going to put all $100 on black for a single spin, while Mr Many Bets is going to put $10 on black for the next 10 spins.

With Mr One Bet, given the house advantage in roulette, there is a 53% that the casino wins the $100 bet.  However, with Mr Many Bets there is a 57% chance that the casino comes out ahead, because here the gambler is giving the casino 10 chances to let the house advantage work for it.  With Mr. Super Many Bets (bet $1 on each of the next 100 spins) there is a 72% chance that the casino will come out ahead.

You can apply that to investing, using your house advantage, with dollar cost averaging.  By investing over time, sometimes you’ll buy after a market run up when stock prices are relatively expensive, but sometimes you’ll buy after a market downturn when stock prices are relatively cheap.  Knowing you have the house advantage on your side, you’ll win this game more often than you lose.

 

Play the games that you know you can win

You’ll notice that Las Vegas has craps tables, blackjack tables, slot machines, but they don’t have games like trivial pursuit or chess or pop-a-shot.  The reason?  Casinos know, calculated with incredible precision, what the odds are of them winning.  They only pick games which give them a house advantage where over time they are guaranteed to win.

They don’t have a casino game called, “try your luck against our grandmaster in chess.”  Why?  What would stop Gary Kasparov or Magnus Carlsen from coming in, placing some major bets, moping the floor with the casino’s “club pro” and walking away with the casino’s money?  Nothing, other than the fact that the casino don’t to play games where they don’t have a house advantage that guarantees that they win over time.

How does this apply to you as an investor?  You should only being investing in stocks and mutual funds that you are confident will allow you to win over time.  The US stock market has over a century of history that shows that over time you’ll always come out a winner.  You can’t really say the same thing about the Argentina stock market.  Stocks and mutual funds as an investment class have a similarly long history, but Bitcoins don’t so you may want to stay away.  Treasury bills have been around for a really long time and are pretty well understood, while peer-to-peer lending is a newer innovation that might work or might crash and burn.  The moral of the story is when you’re investing your nest-egg, make sure you put your money in the investments that you know will give you that long-term house advantage.

 

Offer something for everyone

While the casinos only offer games that they know they can win, they do offer a tremendous variety of games that appeal to everyone.  There are slot machines that appeal to one type, table games like craps and roulette that appeal to another, sports betting for others.  There is something for everyone, and why is that?  The casinos don’t want to put all their eggs in one basket and just appeal to one type of gambler.

Also, they don’t know what types of gamblers are going to come in.  On Super Bowl Sunday or during the NCAA basketball tournament the sports books do a lot more business.  On a tired Tuesday in July it’s the slot machines that are carrying more of the weight.  By having different games to appeal to different types of gamblers, they can maximize their business no matter the time of year or how the gambling tastes of their guests change.

For investors this is analogous to diversification.  There are a ton of investments out there—stock, bonds, commodities, real estate.  And even within those there are subdivisions; stocks can be domestic or international, emerging markets, sector-specific.  The more you diversify, the more likely you’ll be to participate in the overall growth of the world economy.  Certainly some areas will do better than others, but proper diversification allows you to lower your risk while maintaining your higher returns.

 

The casino industry is one of the most profitable in the world because they have the house advantage and swing it like a 2×4.  Fortunately, the investment gods blessed ordinary people like us with that same house advantage when investing.  So long as we follow some of the lessons of our casino friends, there’s no reason we can’t rake in the investment profits like they rake in the gambling profits.

Smarter than a Nobel Prize winner

I’m making a bad habit out of taking extended (very, very extended) breaks from the blog.  What can I say?  I guess being retired can keep you pretty busy.  In fact, in retirement I have been doing a lot of freelance consulting work which has been fairly lucrative, but more on that in a future post.

Since I last posted, so much has happened in the investing world, so we have a lot to cover.  However, the thing that deserves the most attention is the roaring bull market we have enjoyed over the past 12 months.

 

Smarter than Schiller

Back in 2015 Robert Schiller, who had just recently won the Nobel Prize, wrote an article warning investors that future returns might not look so good.  I took the contrary position, thinking that stocks would do well.  Of course, since I’m bringing this up it must mean that I was right and the Nobel Prize winner was wrong.  Ha.

Stock performance since March 2015. The red line is international stocks and blue line is US stocks

As it turns out, US stocks are up an incredible 18.5% since then and International stocks are up 6.8%.  Those are pretty heady numbers, and hopefully you were invested and enjoyed the run up.

To be fair, when Schiller reads this and comments on this post (I am sure he is a loyal reader) he will certainly point out that he was making comments about the long term (let’s say 20-30 years), not just the next 2-3 years.  That’s fair, but facts are facts and the so far the race is not looking good for Schiller’s predictions.

 

The more things change the more they stay the same

Let’s look at the world and how it has changed since Schiller’s predictions, and try to figure out what has driven the changes.  The world’s a big place with a lot of stuff happening so I’m not going to cover everything, but here’s my short list of major developments that have impacted the stock market:

Greece—Two years ago Greece dominated the financial headlines.  The questions of whether or not Greece would get a financial bailout, if it would stay in the European Union, if it would continue to use the Euro, and the broader idea of how much austerity was too much were paramount.  Somewhat predictably, the EU waited until the last second before giving Greece the necessary loans, and the world kept on going.  I’m no expert, but my sense is Greece is still an economic mess but, as politicians are apt to do, it was easier to kick the can down the road.

Brexit—After the Greece drama, in June 2016 Great Britain voted to leave the Eurozone.  The vote was not expected, and it sent crazy reverberations through the stock market for the next couple days.

US starts raising interest rates—Back in 2008 during the great recession, the federal reserve and the rest of the world banks slashed interest rates to near zero.  And there they stayed for many years.  Many questioned if we were in a new normal.  However the US economy started to strengthen and in December of 2015 they raised the rate for the first time in seven years.  At the time this was such a major news event in the financial press it’s hard to overstate it.  Since then they have raised rates three more times.

Trump election—And the biggie.  Donald Trump defied all odds, first by capturing the Republican presidential nomination and then pulling off a shocking upset over Hillary Clinton to become the US’s 45th president.  He ran on a platform being pro-business and bringing a “business know-how” to the office.  Without getting too political, it’s been a bit of a roller coaster, but the US stock market is up about 16% since he was elected 8 months ago.

 

Keep on truckin’

Those are just my short list, and each of those could have a multi-part post.  In fact, at the time they produced thousands of articles and opinion pieces.

The point with all those, and also my point at the time of Schiller’s prediction and my rebuttal over two years ago still stands—we have a tremendously strong economy and things just keep on truckin’.  It’s impossible to predict the stock market in the short term, and certainly Schiller would agree with that.  I think it’s also impossible to predict when the stock market is going to fundamentally change for the foreseeable future, as Schiller did.

In the intervening 2+ years since Schiller’s prediction amazing things have happened to the US and global economy.  The US is producing nearly as much oil as Saudi Arabia (who would have thought) thanks to technology breakthroughs.  That’s employed thousands and lowered the price of oil to billions.

Airbnb and uber have revolutionized fairly old industries and ushered in a “sharing economy”.  Self-driving cars are now on the road and have the potential to bring the biggest life change in a generation.

The point of all this is since Schiller’s prediction back in March 2015 so much good stuff has happened.  So much innovation has occurred and so much value has been created.  Maybe the point is all that doesn’t seem abnormally high, it’s just what happens every month and every year.  And I think it would be foolish to think that won’t continue in the future.

 

In my first post in a while I wanted to make sure we reflected on how well the stock market has done despite some of the smartest people in the world saying our best days are behind us.  I promise I will be posting regularly now, and we’ll continue to look at the best way to get fat off of our investments.