The Confident Investor

If you retire at age 67, do you have enough money to spend to keep you active for another 20 years after retirement (1,040 weeks)? That is what the actuaries reasonably expect you to have to do. Can you:

• Pay for 2 rounds of golf a week plus a cart (probably $100 per week or $100,000 for the rest of your life).
• Take 5 plane trips per year at $400 per round trip ($2,000 per year or $40,000 for the rest of your life).
• Stay at a decent hotel for 3 weeks on those 5 plane trips ($100 per night or $42,000 for the rest of your life).
• Pay for dinner for two with wine at a nice restaurant twice a week ($100 per night or $208,000 for the rest of your life).

While you could say that none of this is necessary, that isn’t the point. Why would you want to cut back on the nice things in life just because you are retired? If you want luxury in retirement then you need to start planning today for that retirement lifestyle.

There are people out there that will give you a guess in how much money that you need to have saved up. Let’s do some simple math.

This adds up to pretty close to $100,000 per year after tax.

Most social scientists say that the upper middle class starts at $100,000 per year and that is where our quick budget above showed as well. If you retire at the young age of 67 and plan to actively live your life for another 20 years until you are 87 that would mean you need about $2,000,000. You may live until you are about 100 but you will be less active in that time of your life, so let’s assume $50,000 per year for those 13 years (you will probably drop the car, golf, and some of the vacations). That is an additional $750,000.

Do you think you will have $2,750,000 in the bank at age 67?

But is that good enough? Doesn’t the above list mean that you will still have a budget? Don’t you want to do all of the above and still have money left over for some real fun? Don’t you want to splurge a little to reward yourself for a lifetime of hard work?

We don’t want to just live well; we want to live in luxury. We don’t want to budget for anything. If we want to take an extra trip to Europe, then why shouldn’t we do that? If our daughter or son is having a new baby, we want to be able to buy a plane ticket in the morning and be there in the afternoon – and the last thing we are worried about is our bank account. Let’s bump this up to an additional 30% per year, just to make sure. Let’s plan on spending $130,000 per year during our active retirement years.

In addition, we don’t want to live in some ratty nursing home when we finally slow down. We want to live in a very nice retirement village where medical professionals and cleaning staff are available. Also, if God forbid we out-live our partner, we don’t want to be in a small room with a snoring roommate that suffers from flatulence. Let’s bump up our less active needs to $75,000 and make sure that we have enough cash to get a private suite and a young nurse to push the wheelchair.

To make this even tougher, not only will you need $130,000 per year to spend on the first year of your retirement, you will need a bit more the next year as inflation will take a slightly larger bite out of your spending. It is hard to predict exactly what inflation will grow at, but 2% should do nicely for an estimate.

Do you think you will have $3,600,000 (or more to account for inflation) in the bank at age 67?

Most people won’t have that kind of money saved up nor will they need to if they are smart about their investments while they are retired. Since you will continue to live for those 33 years until you are a centenarian, you can continue to invest. At this point, it is all about managing your cash flow and making sure that you are investing even while you are retired.

If you follow the advice of this site as well as the advice from my book, The Confident Investor, you will find that you will need less than half of that $3.6M in the bank when you retire at 67. In fact, you will be able to retire in luxury for less than $1.6M!

Let’s be honest, $1.6M is not a small amount of money to accumulate. In fact, if you only count on your own efforts to accumulate that much money in the last 20 years of your earning life, you would need to set aside $80,000 per year! If you start earlier in your life (say at the age of 30), you would need to set aside over $43,000 per year! This is a lot of money and obviously stuffing money into your piggy bank is not going to cut it!

I will show you how to manage your portfolio to allow you to live in luxury while you are retired on my site and in my book. A quick glimpse though shows that compound annual growth of S&P 500 for 1995-2010 was about 8%. A really well invested stock portfolio should be able to double that amount but most people get a little skittish about planning for 15-16% growth. We need a balanced approach that allows your capital to grow but still be there when you need it.

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Editors Note: Comparing different investments with different dollar amounts and time periods is arithmetically more challenging than it first appears. When I do my side-by-side comparisons (such as IBM, Decker, or Boston Beer), I always do the same dollar amount and the same time period. Simon does a really good job of explaining how to do this if they are not the same dollar and time period.

Guest Post by Simon B Veal

Ralph and Jackie are both keen investors in the stock market. In this article I’m going to explain how they can use two different methods of calculating a rate of return in order to compare the performance of their investments.

Ralph buys $1000 worth of stock in AlphaCorp. He holds it for exactly 2 years and then sells it for $1200. Jackie buys $3000 worth of stock in BetaCorp. She holds her stock for 1 year, and sells it for $3300. Just to keep the example simple, we’ll assume that neither Ralph nor Jackie receive any dividend payments from their stock.

Ralph and Jackie now want to compare their investments. They know that there are two main methods they could use: the Arithmetic Return and the Logarithmic Return (often shortened to Log Return).

Ralph’s total profit is $200, and Jackie’s is $300. So this tells them that Jackie has made more money overall. But she also invested more. Investing more usually means she took a greater risk (if the stock went down she would lose more money). To take this into account, they want to know the profit as a percentage of the amount invested. This is exactly what the Arithmetic Return gives them.

For Ralph’s investment in AlphaCorp the arithmetic return is 20%. For Jackie’s investment in BetaCorp the arithmetic return is 10%. So based on the arithmetic return, it looks like Ralph has made the better investment, as his gained 20% in value compared to 10% for Jackie’s investment.

But notice that Jackie sold her stock after 1 year, while Ralph held his for 2 years. The arithmetic return doesn’t include the duration of the investment, so these values cannot really be compared meaningfully. So now Ralph and Jackie compare their investments using the Logarithmic Return, which does take this into account to give an annual rate of return for each investment.

For Ralph’s investment in AlphaCorp the log return is 9.12%. For Jackie’s investment in BetaCorp the log return is 9.53%. Both of these are annual rates, so they can be directly compared.

So who made the better investment?

Based on the logarithmic return, Jackie’s investment was slightly better than Ralph’s. However, there is a slight caveat to mention, which is that Jackie sold her investment after 1 year, while Ralph held his for 2 years. If she really wants to do better than Ralph over 2 years, she will need to find another investment to make for the second year that does at least as well as Ralph’s 9.12%.

Both the Arithmetic Return and the Log Return are useful ways to compare the return on investments. The log return is normally the best choice for investments that were held for different lengths of time because it gives you an annual rate that you can compare between investments.

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