Monday, July 03, 2006

Retirement: How Much do you REALLY Need?

In my previous post, I noted that I believed that a sensible target for being able to retire (this applies even more if you want to retire early) is to plan to have significantly more income in retirement than when you are working. This enables one to have more "walking around money" to pay for leisure time activities. I have found further evidence of this at the end of the Retirement Report from the EBRI.

The report found that while most workers believe they can live on something like 60-80% of pre-retirement income (and assume that they can live well, since their retired parents appear to have far less income), more than half of retirees actually reported equal or greater income in retirement than when they were working. with one in five reporting higher income. Today's workers believe that they can have a retirement at least as comfortable as their parents, because a) they have earned more throughout their lives, b) they have a large home and c) their parents appear to do fine on low incomes. The problem with this logic is one of competition for services. Todays retirees compete with other low-income retirees for "retiree services". Many of their actual expenses (especially taxes and healthcare) are heavily subsidized by todays workers. Those subsidies may not be available tomorrow, and today's "high-income" workers will find that they are competing for services with other retirees with similar circumstances, so prices for those sevices will likely rise above present levels.

Finally, it is important to note that while today's retirees seem poor compared to their boomer children (at peak earnings), they find themselves in a lifestyle with which they were accustomed. Thus, their needs and wants are simply lower. Todays workers will find the experience far more jarring, and sadly, they may actually not have more income in retirement than their parents do today (while still facing higher prices). Unlike their parents, who won all sorts of subsidies to keep themselves in their houses, todays workers may find that they need to sell their house just to provide income for basic necessities in retirement (thus eviscerating the value of the tax subsidy for which they would otherwise be eligible).

This is why my personal monthly investing cashflow target includes a cushion that significantly exceeds my current net income (not to mention my expenses, which are at this time a fraction of my net income). I have built this cushion into my model to allow for three things. The first is inflation. It will take some time (at my current pace at least) to build this passive income and I want to protect my purchasing power. Second, I want to have walking around money. What is the fun of being a full-time investor, if you can't take advantage of opportunities to use the time-flexibility that investing offers. Third, and most important, I want to ensure that I have streams of income to serve as further capital to make investments.

Indeed, if you are fortunate enough to be able to retire in your mid-50s (or younger), you should plan to expand your capital base. The reason for this is simple. You will need to plan for a rising income in retirement to keep up with inflation (or even better, wages). There are two ways to do so, either you increase the returns on capital invested, or increase the amount of capital invested. Unless you can assume higher risk of loss in retirement than when you were working (unlikely for most people), you had better assume lower returns on capital, and lots more of it.

I am curious to know how others are preparing for retirement. What strategies are you using? How prepared are you?

3 comments:

  1. Every American should have the ins and outs of personal finance in high school to make financial stability both as a working adult and as a retiree a reality not a myth. I agree, the more income you have, the better off you will be in retirement. When I first started working, I was told to spend as little as possible and save 90% of any bonus. I thought the percent excessive but I 100% agree with the concept. When I have had the option for a 401K or 403B, I have taken advantage of it despite the challenges this creates for day to day living. To even have 80% of my income by the time I retire (which I agree is not enough), maxing out these plans alone, I will be nowhere near the required nest egg size. Smart investing, luck and enterpreuneurship are also needed if I hope to retire - not retierment savings from a non-profit position. I think the disucssion should focus on how to become a better investor of your capital be it dollars or your time and what choices will society make for older americans who cannot live on there meager retirement savings?

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  2. I agree that learning to invest capital is a crucial objective of everyone - at least everyone born after 1960 - since we are pretty much on our own.

    I started this blog because I want to be a better investor, and share with others what I learn - and get some good feedback like yours on how to learn and faster.

    I have been on a bit of a hiatus due to some computer issues and a much need vacation, but keep reading, and I will resume posting in the upcoming week.

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  3. Cool guestbook, interesting information... Keep it UP
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