How to use time to potentially double your retirement income in five years
Reprinted courtesy of MarketWatch.com.
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(Editor’s note: The following column is an update of the first Retirementors column Mr. Merriman wrote at MarketWatch on Nov. 14, 2012.)
Today’s column is a slight update to a piece I wrote many years ago that was one of the most popular columns I have written for MarketWatch. I believe the information is just as valuable now as it was in 2012, so why not revisit it?
Most people facing retirement would leap at the chance to double their income during the “golden years.” If you’d like to do that, I’ll show you how. And if you are wondering what the answer is, look at your calendar. We’re talking about time.
One of the most important financial decisions we face is the question of when to retire. Sometimes it’s very easy; sometimes it’s very tough. Either way, the decision has far-reaching consequences.
Retire too soon, and you could run out of money. Retire too late, and you could miss out on some of the best years of your life, doing things you may have dreamed about for years.
For some people, the choice of when to retire is dictated by health or family circumstances. A few fortunate individuals may acquire enough wealth that retirement becomes a no-brainer. But for most of us, the timing is a tug of war that we can resolve only by taking a leap of faith, hoping for the best, or at least something within reason.
A common rule of thumb
Financially, the issue is whether — and when — you have enough money to retire. Financial planners have some rules of thumb to help. Like all rules of thumb, they sometimes work … but not always.
Perhaps the most common is the rule of 4%. This rule asserts that a properly diversified portfolio of stock funds and bond funds will likely last through retirement if you take out no more than 4% of its value every year.
In practical terms, that means your portfolio should be equal to at least 25 times the annual amount you need in order to supplement Social Security, pensions, rental income and any other source of retirement income you can count on.
There are a lot of unknown factors in the equation, including the future of inflation, the markets, the world economy, interest rates, your health, your longevity, emergencies — this list could go on and on.
In 30 years of being a financial adviser, I went through this conversation with hundreds of individuals and couples. Often I would hear questions like these: What if the market goes down immediately after I stop working? What if I underestimate how much it will cost me to live? What if my spouse is perfectly willing to live a modest retirement lifestyle, then changes her (or his) mind?
Although many important things about our future are beyond our control, we don’t have to know the future to know the difference between what’s barely enough and what’s obviously ample. When I worked directly with investors, I wanted to get them closer to the latter amount than the former. The best way to do this is to have a financial cushion or a margin for error.
What you have vs. what you should have
The simplest way to achieve that cushion is to have a larger portfolio available when you retire. This is elementary grade-school math, and most people figure it out as they are nearing retirement age and realize there’s a significant gap between what they have and what they should have.
The wrong way to try to close that gap is by taking more investment risk, yet many people follow that course. Once in a while this works, but more often it backfires, leaving people with less money instead of more. This is certainly a poor way to plan your future.
Where time comes in
Often, the best way to build that cushion is to postpone retirement a few years. Obviously not everybody can or wants to do this. But if you can, consider the benefits.
- If you’re adding $20,000 a year to your retirement savings, working an extra five years can add $100,000 to your portfolio.
- If those five years are ones with normal returns in stocks and bonds, your existing portfolio (plus your last $100,000 in savings) will grow.
- Working an extra five years probably won’t change your life expectancy. This means your portfolio will have five fewer years during which it has to support you.
- If you delay taking Social Security, your benefits (and your surviving spouse’s benefits) could be as much as 50% higher. That reduces your need for money from your portfolio while that portfolio is gaining the strength to pay you more.
- As your portfolio grows, you may need less return. You can take less risk, which should give you more peace of mind.
- By saving more and waiting longer to tap into your savings and Social Security, you may be able to boost your portfolio at retirement by 50%. If you then take out 5% a year instead of 4%, you may effectively double your annual retirement income. And you’ll probably have more to leave to your heirs.
This could give you what I regard as the ultimate financial luxury: Retiring with more money than you’ll need. It’s as close to a win-win solution as I know.
Here’s a relevant article I wrote subsequent to the first publication of this one: How you’re being misled by retirement-saving advice.
Earlier this summer, I was a guest on the weekly radio show of fellow MarketWatch Retirementor Ken Roberts. Click here to join Ken and me for our discussion of some of the most important investment decisions investors make.
Richard Buck contributed to this article