Uncommon Cents

Liars, damned liars, and statistics; it’s hard to come up with an out and out number that just says, “If you have this much money, put it in this kind of portfolio, and withdraw this percent per year, you can live on it forever and not worry much about draining your principle,” but I’ll try anyway.

Advice and historical numbers that are given out and often pass for facts are really not; as any investor has heard over and over, past results are not an indicator of future success. Still, history seems to be a great teacher in many ways, so some of these could be useful; in some cases, I’ll round off the numbers to make the math easier.

Average yearly stock market return: 10%

Average yearly bond market return: 5%

Average yearly core inflation rate: 2.5%

Percentage of a balanced (50% broad stock market, 50% quality bond) portfolio that can be withdrawn yearly without affecting the principle of the portfolio: 4%

Percent of income while working required to maintain a similar lifestyle after retirement: 85%

Let’s say I’m making $50,000 a year (which is a very decent salary for a social worker, but it’s not my salary); using the 85% guideline, that would make my retirement income need $42,500.

That’s a very simple look at things and it could be glaringly incorrect. For instance, let’s say that yes, my income is $50,000 a year, but I put 10% of that into a 401(k) or 403(b), so it’s pretax dollars that are gone before I can spend it. I certainly wouldn’t be putting that money away for retirement if I was already retired, so instead of my gross being $50,000 a year, it’s really $45,000 a year for purposes of this exercise; that would make my retirement income need actually be $38,250 a year.

So if that’s how much I need to gross a year, I’d like it to be equal to no more than 4% of my total portfolio; that $38,250 would be 4% of a portfolio worth $956,250.
$956,250 is, of course, nothing to sneeze at; it’s also a figure that’s in today’s dollars. Inflation makes calculating this a bit of an issue. Inflation of 2.5% a year doesn’t seem like much, but over time, it can add up. In 20 years, that $956,250 needs to be $1,606,100.15!

So let’s say that I currently have total investments in the stock market and the bond market totaling $75,000–3/4 of that ($56,250) in stocks and 1/4 of that ($18,750) in bonds. Let’s also say that every year I put away another $5,000–3/4 of that ($3,750) in stocks and 1/4 ($1,250) in bonds. Using those figures along with an Excel spreadsheet and the 10% stock market and 5% bond market returns listed above, in twenty years, when I’d like to have $1,606,100.15 socked away, my little portfolio has less than 1/2 of that–$779,392.69–at my disposal. The news gets better with more time, however; in another 12 years–32 years total from the time I started–I finally get to my inflation adjusted goal. That $956,250 number has become $2,107,342.57, but my total portfolio has become $2,205,515.60.

While it’s amazing to see how money grows over time with average returns, it’s also disappointing to see just how long it took my savings to get where we wanted it to be. However, playing with the numbers can help us in a lot of ways. This is something we’ll look at in a coming entry, as well as a discussion on the importance of being frugal.

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