Retire with 3 million?

Headline – A couple tried to retire with 3 million – and it wasn’t enough! You often hear or read these kinds of stories. And it’s often a question of whether the capital sum they had managed to accumulate was enough under the economic circumstances, in other words giving the combined effects of inflation, interest rates, and stock market returns.

Retiring young

I stumbled on one like this a few weeks ago and quickly read through the account of a couple in their thirties, living in San Francisco, who set themselves up to retire with 3 million – actually it was about 3 and a half million. They both had high powered high salary jobs and they thought they had done their calculations. But about five years later after retiring in their mid-thirties, they had to go back to work… because …

and this could be where we start playing … spot the mistake …

… because of low-interest rates, the income from their capital didn’t match their outgoings.

So was this an honest mistake, did things just not turn out how they thought or had hoped … had they read this earlier article on how much money they need to retire … or had they just followed some Bad Investment Advice?

It all sounded so reasonable

Capital growth chart

The story goes that this married couple added up all their commitments, all they needed to live on an ongoing basis including health insurance, emergency funds, and enough for vacations, other travel and a few other luxuries. They already owned their home so they didn’t have to bother with mortgage repayments.

They worked out that the needed about $170,000 in pretax income per year and they worked out that with a conservative rate of return of 5 percent this meant they would need a capital sum or 3 and a half million dollars working for them.

Sinking interest rates, diminishing returns

But then five years later they found they could no longer get a steady and guaranteed stable 5 percent return with Down market chartsafe government bonds and they didn’t want ot move into riskier investments.

Living in one of the most expensive cities in the country couldn’t have helped and moving away wasn’t something they wanted to consider. Now instead of 5 percent returns and $170,000 pretax income or slightly more, they were only able to get around 4 percent which was grossing $140,000 before tax. They also didn’t want to eat into their capital …

So they went back into the workforce.

Investment horizon.

So what is wrong with this picture?

It’s all a matter of choice really. They made their choices for their own reasons and that’s all good for them. But on the face of it there is an opportunity missed.

One of the first things they should have considered is that in your mid-thirties you still have an investment horizon of 50 years or more. With that investment horizon, they should have been  – I would argue – at this stage fully invested in the stock market. A conservative approach to stock investing would be under these circumstances a managed investment fund linked to the Standard and Poor’s stock index..

Why the Standard and Poor’s and not the Dow Jones or the Nasdaq? The Standard and Poor’s is the usual shorthand for the Standard and Poor’s 500 index. The index tracks the share prices of the 500 largest US-based stocks, weighted by market capitalization.

Stock market investing

And weighted by market capitalization just means that price fluctuations of the companies with the largest market capitalization affect the index more than similar price fluctuations of the companies with smaller market capitalization. This article explains more about market capitalization.

The Dow Jones 100 does much the same for the 100 largest companies and the Nasdaq composite index does much the same but only for companies listed on the Nasdaq exchange which includes many small and micro capitalized companies. History shows that the Standard and Poor’s 500 index is the more broad-based and stable indicator of what the stock market is doing. We’ll look at the long-term performance of the Standard and Poor’s shortly.

Factoring inflation

Bull marketOne of the most important considerations with such a long investment horizon is that you will need to ensure your capital to grow at a rate that matches and certainly in the first 25 of those 50 years outpaces inflation.

In the second half of that 50 year period, you could afford to slowly eat into your capital unless you want to leave a large legacy for family or other dependents.

Let’s say inflation is running at 2 percent a year. Depending on the consensus on where inflation is going and there are many market indicators or pundits that can tell you this, you might want to set aside 2.5 percent a year for capital growth to stay ahead of inflation. But I would check this every year and increase it if actual inflation inches close to that 2.5 percent.

So, let’s say you have your 3 and a half million. The Standard and Poor’s Index has averaged an 8 percent annual return from 1957 to 2018 and varies over other periods as we will see later.

Going back to the example of the San Francisco married couple, they were looking for a pretax income of $170,000 a year. Simple – they take the 5 percent return leaving a half percent buffer if the market doesn’t quite perform in the first year.

Once they have passed the first few years, their capital would have grown beyond where they safely needed it to be.

Did you spot the mistake?

This time it was my mistake and would rightly qualify as another piece of – Bad Investment Advice!

Implied in the statement above is the idea that a half percent buffer in a first-year investing in a Standards and Poor index funds would be enough against poor performance.  Anyone who has owned stocks would know that is a wildly optimistic approach.

The chart below shows the Standards and Poor year on year return from 1974 to 2019.

The blue line in the chart is the annual return. As you can see it’s pretty much all over the place. Over this period there were annual returns in excess of 30 percent gain in 1975, 1980, 1985, 1989, 1991, 1995, 1997, 2013 and 2019.

That means that a portfolio of stock that mimick the Standard and Poor’s 500 index would have increased in value by more than 30 percent in those years.

But there were also bad years. Between 1974 and 2019 there were nine years when that same portfolio of stocks would have lost value. And some of those years the losses were substantial, the worst being 2008 a loss of 37 percent, 1974 a loss of 26 percent and in 2000 a loss of 11 percent.

As we can see things look better if you average the returns over longer periods. The dark orange line shows the average returns over the previous five years. It stays mostly positive, but even over five year periods in this same time window from 1974 to 2019 returns can be negative or close to zero. It is only when we extend the window to ten years that it stays positive, that is the yellow line. Only the darker red line which is the 15-year average stays comfortably positive and above inflation.

Back to our couple

So how does all this relate to our San Francisco couple trying to build a pile of money to retire. Well, they were still in their 30s and both were highly paid. Let’s say they took 15 years to build their nest egg and they retired in early 2020. The average return of the Standard and Poor’s over that 15 year period was 10.47 percent which was actually 2 percent lower than the average over the whole period from 1974 to 2019 we looked at earlier.

There are many ways they could have built that 3 million dollar pile but let’s imagine they started with a gift of $100,000 and were able to save most of one salary at say $6,000 a month. Here’s what that would look like.

15 year savings plan 100k start

In this case, after that 15 years they would have ended up with $3,190,904.

If they hadn’t had $100,000 to start but still wanted to build their capital in just 15 years. In this case, they would have to find $7,000 a month to put in their savings plan. As the chart below shows.

15 year savings plan $0 start plus $7,000 a month

And in this case, their nest egg at the beginning of 2020 would be $3,298,569

Shifting balance and shifting behavior.

In the case it would make more sense to build the capital further to 5 or 6 million and then as they advance through their investment and payout period, it would make the most sense to shift gradually away from stocks and into bonds. There are all kinds of rules and best practices like a 60/40 percent stocks and bonds balanced portfolio and that people in retirement can use 4 percent of their capital every year to use it up over their retirement years.

But more about all that another time.

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  1. Great advice for those in this situation. I only wish I had the money to invest! Thank you for sharing.

    • Hi Dolly. Most working people would probably not find themselves in this situation with so much surplus disposable income that they could afford to retire so early. I think the real point is that $100 set aside now will be worth $200+ in 10 years and $1,600+ after 40 years. And for many of us, 40 years is a typical span in the workforce. Thanks for your comment.

  2. 60 years old, sold my company. The proceeds 3 million after taxes. 3 year contract to continue to work. 30+ industry experience, signed non compete. 63 will be retirement. Desire income of 120k without tapping seed money. 1) where to invest for 3 years 2) should I take SSI to offset at 63

    • Congratulations on selling your company and on having made clear decisions on your path forward. That should make it easier to decide how to invest. However, three years is a comparatively short time for investing, withdrawing income, and being nearly certain to avoid any erosion of your capital. A usual time horizon to be more or less certain that your invested capital would be able to recover from a market downturn of around 10 to 15% would be seven years. Your desired withdrawals are 4% of your capital. That is almost but not quite achievable with dividends and certainly not achievable with bonds or CDs. Also, inflation is going to take a big swipe out of your nest egg. The one place you could be reasonably certain of the needed returns on investment would be the stock market. The logical thing to do would be to invest in a mixture of around a dozen passive indexed Exchange-Traded Funds that give you a diversified spread of exposure, like SPY, QQQ, IWM, probably mix in some growth funds like IWF, value funds like EVF, and robust dividend equities like SPYD. Since you intend to retire at 63 it probably does make sense to take SS at 63. Don’t be lured by any crypto nonsense or other get-rich-quick investment schemes. The internet is riddled with them. Also, your time horizon is a little short to get involved in real estate which will continue to go through a lot of turmoil as the economy and lifestyles adjust following the pandemic experience.
      The best advice though in all honesty would be to have a session with a fiduciary financial advisor. They will be able to take all your financial situation into account: all existing investments, assets, liabilities, and your tax situation. You will probably pay a fee upfront if you want to manage your own investments following their advice. Or you could work with a money manager like Fisher Investments. You will have more than enough to qualify as a high net-worth individual. But anyone who is working on commissions from products they sell you will not give you honest advice. The important thing to look for is that the advisor is working in a fiduciary capacity. The investment decisions you will be making in a short space of time are so important, it will be worth spending a modest amount to get good advice that fits your circumstances.
      Here is an article that explains the fees charged by financial advisors.
      I hope this helps, thanks for sharing your situation and I wish you the best of luck.
      Best regards

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