As promised on Friday, I am going to delve into my retirement plans and share what I intend. Knowing what I know about inflation and purchasing power, I think you will find that this is a well rounded approach to the risks that will be present should I decide to live for 25 or 30 years following the day I quit my day job. It is not a really sophisticated plan per se with lots of fancy calculations, but is aimed at providing a living income for my wife and I with some extra money for travel purposes as well.
Risks to Retirement Funds
There are several risks to your retirement funds. Most people are well aware of the risks that particular investments have such as loss of capital. They tend to focus on this and so place their money into “safe” investments such as bonds or CDs. I know several older individuals with a fair amount of capital in savings accounts paying less than 1%.
There is also the risk that you might outlive your money. I have been reading a lot of articles about finding the perfect draw down percentage. If you take out too much of your portfolio in the early days of retirement, you may not have enough if you live longer.
Finally, there is the risk of inflation eating away at your purchasing power. Not enough retirees consider the impact of 25 years of inflation. I was in college 25 years ago and remember getting 2 pizzas for $5 from Little Caesar’s. I can also remember when gas cost less than $1 per gallon and a coke was 25 cents out of the vending machine. Whoa! I am afraid to tell you what else I can remember.
Anyway, these are the biggies so what plan do I have to not only provide me with a decent retirement, but also to mitigate and neutralize those risks. Enter the three pronged strategy.
Enter Retirement Debt Free
This is by far the most important criteria that I will insist upon before I am able to retire. This includes mortgages, school loans, wedding expenses (I have 4 girls), etc. I refuse to have a single penny of debt when I stop working. I want to know that all of my income in retirement will be going to support me and my wife.
This is what I am starting to work on now. Unfortunately, I did a really good job of saving for retirement. So much so that right now, cash flow has been hampered to some extent (more on this later). But, I am confident that it can be done now that I am increasing my focus.
Income Producing Real Estate
The second prong in the strategy is to have some income producing real estate which will provide monthly income to pay for our living expenses. Right now I have some rental property. I also have mortgages but the plan is to have them gradually paid off over time such that when the time to retire comes, the rent can be pure profit save for some of the expenses.
I also plan to manage myself in order to provide me with something to do. I am sure that I might get bored playing golf and shooting 7 or 10 under par every day (LOL). Of course, if I get too old and frail or want to spend months at a time on the road, I can always pay for property management.
The return on investment will be much better than a savings account, and I might even be able to raise the rent every so often to help mitigate the impact of inflation on my own expenses.
I figure that half of my assets should be in real estate and the other half in stocks or some other paper type of asset like an annuity or private pension. I want to know that all of my income from any private pension schemes will be going to support me and my wife. The plan will be to live off the income from the real estate while letting the stock portfolio grow until mandatory withdrawals are necessary. Of course, then I will have to take the money out but I shouldn’t need much of it if the real estate covers my costs.
Isn’t investing in stocks risky? Not if you use protective puts and sell covered calls like I have been doing. I don’t have to worry about a market like 2008. As I move into more dividend stocks, that volatility should decrease even more. I have developed a great system that is working for me. Maybe someday I will share the results.
As for a draw down percentage, it shouldn’t even matter. I don’t plan on touching any of the principle between the real estate income and the dividend payments. Once I have decided this, it simply becomes a matter of figuring out how much rent I need to collect and make sure that I can cover my costs.
For example if I want to have $10,000 in monthly income, assuming that I will have about 25% expenses between taxes, insurance, vacancies, and maintenance, I will need to collect just over $13,000 in rents. That means I need to have about 13 houses locally. So that becomes my target goal for real estate.
I obviously need to pay off some more debt and get some cash for real estate if I want to get to that level of monthly income. If I need less, then I need less real estate. You can see how I am not necessarily looking at a particular number of $3 million or $4 million to retire, but looking at the income that can be generated by rents. In my area, 13 houses is about $1.3 million so that number seems easier to achieve than $3 or $4 million.
So that is the general gist of my plan. I don’t have to worry about inflation since I have it covered with rents and stocks. I don’t have to worry about investment risks of stocks due to the protective puts and my knowledge of options. I don’t have to worry about a draw down calculation since I will be living on rents anyway. Thus, I won’t have to worry about outliving my money.
So, I just need to worry about my debt!
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I was reading an article on retirement this morning and came across a term I had never heard before, money illusion. It is the name for the phenomenon that psychologists and behavioral economists give people’s tendency to overestimate the value of future dollars. In other words, we have a tendency to underestimate the effects of inflation.
That is understandable because it has only been about a working generation ago that Nixon closed the gold window allowing paper currency to begin its rapid loss of purchasing power. In retirement, purchasing power and translating savings and investments into a lifestyle is the ultimate goal and few are thinking in such terms.
Instead, the goal is to save a certain sum of money regardless of the amount of income that those savings generate or the stuff that could be purchased. So retirees can run the risk of running out of money over the 25 or 30 years of living following retirement, not because they didn’t save enough, but because they underestimated the impact of inflation on those savings and failed to keep pace.
Keeping Pace With Inflation
In order to maintain purchasing power over three or more decades of retirement, an investor should invest for the right combination of income and growth. Historically, the inflation-adjusted returns of various asset classes from 1926-2010 are below. The assumption is that $1 was invested in each class at the end of 1925 and held through the end of 2010 (Be sure to visit the link to see the cool graphs).
- Large US Stocks: $244
- Long US Corporate Bonds: $7.60
- Long Treasury Bonds: $6.88
- Gold: $5.62
- Treasury Bills: $1.68
- Cash: 8 cents
Real estate is another asset class which is often touted for its ability to keep pace with inflation. Its real return from 1900-2010 turns out to be 0.2% per year such that $1 invested in property in 1900 would be worth $1.25.
What Will You Do With This Information?
Now, the question is: Will this information change your behavior? There are many personal financial bloggers wanting to retire early and live off their investments. How are you invested? Are you planning on being in 100% stocks for the next four or five decades? How will you manage your risk?
You may decide to invest in bonds since the stock market is viewed as too risky. But are you then underestimating the effects of inflation? Will you be living off only the income that your investments provide? Will you be drawing down from your assets or adding to them? How will you ensure a certain level of income? How can that income keep pace with inflation?
These are the sorts of questions that everyone looking at retirement should be asking and answering, not just those looking to retire early than what is traditionally considered retirement age.
Your Retirement Plan
So what is your retirement plan? I am not talking about an IRA or a 401(k). I am talking about how do you envision getting the necessary income to live through 30, 40, or 50 years of “retirement”. I have spent a lot of time thinking about this myself and have a decent plan in my estimation. I will write it all down and share on Monday. But in the meantime, what is your plan? How will you maintain purchasing power? Feel free to share in the comments.
It has been a very unproductive week as I have been fighting a stomach virus and am probably only about 80% of normal currently. I am on the mend and should be back to 100% in a few days, but the day I had off work to go Christmas shopping found me in bed until 6 pm. Then I got up for 4 hours and went back to bed. Oh well, life happens from time to time. I plan to get a little caught up today on the past week’s mail.
Stock Dividend Links
In the meantime, I have some links that I would like to share with you. Since I have thinking about stock dividends lately and will be sharing my plan for increasing my own dividends in tomorrow’s post, I thought I would share link based upon that theme.
First up, Mark talks about BP as a dividend play. I think everyone needs to have some exposure to energy stocks since it is such an important part of daily life.
Next up, Dividends4Life shares Dividend Stock to Shield Your Portfolio from Inflation. I have already invested in Intel and am looking at Nucor as part of my plan.
This next link at Dividend Growth Investor has the Aristocrats List for 2012. This is a great list to start with if you are looking to get into dividend investing as the Aristocrats are companies that have increased dividends for 25 consecutive years. So not only are they reliable in their payments, but those payments are growing. Safety and growth is an awesome combination for wealth building.
Money Reasons shares his thought on using dividends to pay for expenses. Personally, I think it is a good idea. I do plan on ultimately using dividends and rental income to fund my retirement allowing the principal to remain intact for generations.
The Dividend Blog Guy has a fun quiz on becoming a dividend investor. I enjoyed it, but was a little disappointed that I couldn’t get my score.
Carnivals Featuring CFM This Week
Next I wanted to provide links to the various carnivals in which I had articles included over the past week. I must say a big thanks to Melissa from Mom’s Plans for doing all this submitting and tracking for me. I would be in a grand total of zero carnivals if it were up to me since I barely have time to do what I want to do and enjoy doing which is writing and keeping up with the other personal finance blogs on the web.
With Melissa on the job, I am able to be included in 3 or 4 carnivals each week which is certainly much better than zero.
Carnival of Financial Planning #213 hosted at PT Money.
Yakezie Carnival — Mighty Ducks Edition hosted at 20s Finances.
Totally Money Carnival — Building Wealth Edition hosted at Faith and Finance.
The Wealth Builder Carnival #56 hosted at My Wealth Builder.
Be sure to stop by a few of these carnivals and check out some of the other articles that are featured. I am sure that all you regular readers already had a chance to check out the ones that I wrote.
That’s all I had for now. I need to get going on that stack on my desk and get working on tomorrow’s post. Have a good remainder of the weekend.