By Kevin M
A million dollars was a lot of money when I was a kid. Inflation notwithstanding, for most of us, it still is! It’s an amount the vast majority of people will never have in their bank accounts or anywhere else in their possession.
Yet it’s practically a MINIMUM if you plan on enjoying the textbook full retirement.
Think about all of the retirement scenarios laid out for us in the financial universe; at the heart of nearly every one of them is a big, fat 401k with a seven figure balance to keep us pampered and well provided for in our golden years.
A picture perfect scenario
A million dollar retirement nest egg is as easy to build up as 1, 2, 3—isn’t it?
Let’s run some numbers. Let’s say you participate in your company’s 401k plan, and your income is sufficient to max out your contributions at the current allowance of $16,500. You’re 40 years old, and you’ll be making that contribution in each of the next 25 years. We’ll assume the historic long term stock market average rate of return of 8% per year and that whatever stocks or mutual funds you invest your money in will never under perform that average.
Since this is a perfect world projection, we’re going to ignore the possibility that you could lose your job at some point over the next quarter century, interrupting your contributions for an indeterminate period of time. As well, we’ll assume that another extended zero return (at best) period, such as the decade we just closed out, was a complete aberration and therefore entirely unlikely to re-occur in our lifetimes.
$16,500 contributed each year, for 25 years at 8% will produce a balance of approximately $1.2 million at age 65.
You’ll be a millionaire! That was easy, wasn’t it?
What will it buy you?
From where we sit today, $1.2 million is a big chunk of change. Can you imagine not being able to retire on that much money???
Well, it’s actually quite possible.
We all know that prices rise over time. For reasons too complex to cover here, inflation is built into our economic and financial systems. We can bet on it continuing in the future for all of the same reasons it has in the past—what ever those reasons may be.
Let’s look at what inflation can do to $1.2 million dollars over the next 25 years. Since there’s no way to project future inflation with any degree of certainty, let’s use recent history as a metric. What has inflation done to the value of money over the past 25 years?
The consumer price index, stood at 103.5 in May, 1984, and rose to 212.88 in May, 2009. Translation: a dollar today is worth only about 49 cents compared to the 1984 dollar, or slightly less than half.
Just basing inflation over the next 25 years on the past 25, it’s reasonable to conclude that our $1.2 million will be worth only about half in real terms what it is today, or about $600,000. 50% of our portfolio is vaporized by a factor which is totally beyond our control!
We’re not even going to consider the fact that inflation won’t disappear from the scene once we turn 65 and how THAT impacts the projection!
Weak rates of return on low risk investments
Once we reach 65 will we continue to invest in the stock market, gathering our 8% returns annually? The answer to that will be different for each of us. But I’m willing to bet that by the time most of us hit that age, we’ll be more conservative if only because we’ll no longer have the time horizon to recover from large, sudden losses.
Let’s assume that you’ll invest 100% of your money in super safe 10 year US Treasury notes, currently paying 3.71%. To keep it simple, we’ll round that number up to 4% even. 4% of $600,000 is $24,000 (remember, we’re adjusting the $1.2 million down for the ravages of 25 years of inflation). That’s $2000 per month.
Can you enjoy the prosperous, golden retirement of your dreams on $2000 per month?
It’s kind of humbling isn’t it? $1.2 million dollars—a very impressive pile of money from where we sit today—reduced to a benefit of just $2000 per month? It almost doesn’t seem worth it. That’s a lot of doing without during your working years to provide a relatively modest benefit at the end.
But let’s touch on something even more basic. While we can “see” the possibility of accumulating a seven figure retirement balance through regular contributions combined with the magic of compounding over an extended period of time, the fact is—barring a runaway inflation–relatively few of us will ever amass such a fortune!
Are you planning for, or even considering, this possibility?
John Lennon once said, “Life is what’s happening while we’re making other plans.” I was never a big fan of his, but this point is painfully brilliant.
Am I suggesting abandoning the accumulation of money for retirement? No. But what I am proposing is diversification of retirement planning, in much the same way we might diversify a retirement portfolio. Sustenance from several clearly defined sources. Only by developing them do we begin to truly provide for our retirement years.
And now the Million Dollar Question: what career will you have in retirement?
Can you think of any strategies to help prepare for retirement apart from retirement savings alone?
Another thing to think about is lifestyle inflation. For instance, someone retiring in 1990 wouldn’t have thought a home computer and a mobile phone was a requirement, so they won’t have factored them into their equations.
Some of this washes out, but in an ideal world you’d keep up with income inflation, not real world inflation, if you plan on keeping up with the young Jones’ next door for at least a couple of decades.
Sorry to make a hard job harder!
Monevator – Good choice of words, “making a hard job harder”. That’s kind of the point, the financial media has oversimplified the job of preparing for retirement, as though all we need to do is faithfully make our allotted retirement plan contributions and all will be well with us at 65.
While we’re certainly better off having a fat 401k than being without it, we shouldn’t be complacent about that either. Eliminating debt, lowering living expenses, taking care of our health and finding additional sources of income for what may look more like semi-retirement than full retirement, are all at least as important.
A 401k plan may not be the magic bullet everyone thinks (wishes?) it to be.
This is a sobering analysis. Two things come to mind: 1) People need to work hard to get out of debt and build an emergency savings so they can get to the investing stage of their lives as soon as possible; 2) It’s important to find your life purpose and know what you will be doing in the later years of life. Perhaps fulfilling this mission or purpose won’t require as much living expenses as one might think, but regardless it’s still important to invest for the future.
Jason – Exactly! You’ve said in a 100 words what took me a 1000! (Jason is an oustanding blogger at OneMoneyDesign BTW, and his posts appear on various sites around the web!)
Retirement probably won’t be as simple as the math equation the experts make it out to be. And we haven’t even gotten into the possibilies of future stock market crashes, etc, that will cloud the picture even more. It’s the old saying about not putting all of your eggs in one basket.
I think retirement can be a time to pursue a passion. Some folks work jobs they don’t like for many years. Someone who knows their passion can plan to use retirement to start a part-time business. WE need to have some part-time gigs that flow from interests. Brainstorming ways these interests can be used in the marketplace is a valuable investment.
Ken – That’s exactly where I was hoping to bring this post! We need to think more in terms of redirecting than outright retiring.
With the high cost of healthcare, which especially affects the elderly, as well as the near absence of defined benefit pension plans, only the very rich–those with many millions of dollars–will be able to afford an affluent retirement.
No, it is not nearly enough for most people because they return on safe investments it too low. It is actually less than inflation!
Besides that, in 25 years a million dollars will not have the value of $500,000 today. Maybe $200,000, $100,000 or less.
Everyone needs better strategies than saving in their 401k. Any form of passive income is a good source. Real estate, businesses, blogs, books and eBooks can be great sources.
George´s last blog ..Connecting with Favorite Authors through the Internet
One more round of proof – the sooner you focus on doing things for which you are passionate, the better. Live your life TODAY in alignment with your passions and values (the things that are most important to you). Why wait until you retire (if you’re lucky to make it that far) until you start living?
BTW – How difficult is it to have $1 million socked away? Only about 2.5% of Americans today have that. And yet (using a “safe withdrawal rate” of 4% as defined by the financial planning community), $1 million will generate about $40k per year (below the median family income in America of $50k). Talk about a disconnect. 2% of Americans have the income producing assets to generate the income that 50% of American families are used to.
Properly managed, a portfolio should be able to beat inflation by 3% with limited risk (safe enough for a person aged 65 expecting to live another 20 years). For younger folks, inflation plus 5% is a reasonable target rate of return but for every extra percent of increased target return, you double to quadruple the risk.
How do you get to place where you can thrive on a lower target rate of return? By focusing on your values (the things in life that are important to you) and making different choices not to blow money on stuff that isn’t all that important.
John D. Buerger, CFP® ´s last blog ..Money Control
George – Inflation is the element not spoken of in all of those wonderful retirement projections that promise us millions if we faithfully invest. It may be the most important one, and that’s why it isn’t discussed.
John D – You hit the nail on the head, only 2.5% of the population have a million dollars; while going for it is a worthy goal, it’s best to be prepared to be one of the other 97.5% who don’t. Life won’t come to an end if you’re not a millionaire retiree, any more than it will be a golden road if you are. Once again, the inflation factor.
This isn’t to be negative, but rather to advise that salvation needs to be sought outside of and in addition to the hallowed 401k. And that’s good news for the vast marjority who don’t have a seven figure bankroll.
I think it’s better to focus on cashflow (income from all sources) rather than a sum total number/networth. It’s going to be your monthly cashflow anyway that determines how you live – so who cares if your cashflow comes from a $200,000 balance or a $1m balance? If you’re able to do some basic research you can find places paying higher interest and dividends no problem. Yes, you have to be somewhat on top of it to manage the risk, too – but it’s possible.
MoneyEnergy´s last blog ..Survival Skills To Barter With In Case of Financial Ruin, Unemployment, or Economic Collapse
Sadly, $5 million is the new $1 million of years past. Got to love inflation, and the perpetual up up up desire for more money by all.
Financial Samurai´s last blog ..Book Review & Giveaway: “Get Financially Naked”
No, for many it won’t be.
But – to John’s point, the $50K median income. An individual with a $50K income will see a Social security benefit of about $21K at full retirement age. So. 80% replacement is $40K, only $19K needs to be replaced. It would take $475K to do this.
Social security benefits aren’t linear, as a replacement rate they diminish as your income goes up, but the lower wage earner has a good chunk of their retirement covered.
Financial Samurai – So right, $5 million is the new $1 million. What will the new $1 million be in 25 years? We can only speculate.
It’s back to Money Energy’s point that it will come down to cash flows, and they’ll need to come from different directions.
If inflation of the 70′s returns 1 million will be nothing.
Still wise investing will keep you ahead of inflation.
Daddy Paul´s last blog ..Use your credit card to your advantage
$5 million may be the new $1million, indeed… but $1m is still a nice stepping stone!:) I think the goal should be to make your monthly living expenses in passive income, while continuing to be able to invest on the side.
MoneyEnergy´s last blog ..What To Expect in Stock Markets for February
Good point! But it seems that given inflations ability to wear away current values, relying primarily or exclusively on a retirement portfolio may be insufficienct. Your earlier point about cash flows and passive income sources is where we all need to invest more time and effort.
I’m sure Social Security will make up the difference (LOL
)
I think we still have to try. What else is there to do?
As for what job will I have in retirement? Hmmm, that a good question! I would want to work someplace cool, Disney as a boat driver, or perhaps at McDonalds in Hawaii (like there is a McDonalds in Hawaii hehehe… Hey wait, there are 20 locations of McDonalds in Hawaii for real! You got to love google!).
When you get older, a lot of doors of opportunities are shut and locked for an older job seeker. So try to make lemons out of lemonaide by working in an area where you have always wanted to live
Money Reasons´s last blog ..10 Millionaire Lifestyle Secrets
Money Reasons, I agree, we still have to try.
Your point about employment doors being closed to the elderly is a good one. That’s why I think long term preparation needs to be implemented, and independent business ideas pursued. It could take years to develop these, so planning in this direction is no less important than accumulating money for retirement.
There are so many variables that in order to plan wisely, we have to spread out our efforts. The world just isn’t a simple place anymore.
One sure method: lifestyle deflation. Getting more out of one’s money. I agree that a million is too little for the average family/consumer unit, but it is certainly more than enough for anyone not throwing money left and right.
Early Retirement Extreme´s last blog ..Your budget is like a leaking ship
ERE – Lifestyle Deflation – that’s a cool inversion of the increasingly popular Lifestyle Inflation. Everyone knows what lifestyle inflation is, but your spin tells us what we need to do about it.
I also agree, that it will be possible to have some form of retirement on a million dollars, but it won’t look at all like the TV version of retirement. That’s what will be the eye-opener for many faithful savers.
I could retire on this. I could live on under 30k/year… just the interest alone I could live off of without touching the principle. Of course, i’d probably have to leave the USA… everything here is expensive, overpriced… and taxes would eat up much of this money if you are not careful.
Arthur, you may be able to live on $1 million now, but would it still be enough 10 years into retirement, when the cost of living will undoubtedly be higher. That’s why we need multiple income sources even in retirement.
I’m afraid I’d have to disagree with inflation being completely out of control. Precious Metals do quite nicely to counter against that particular little problem. *Grin*
Equities also serve as a nice hedge against it… As dividends increase more rapidly than inflation does, which preserves cash flow.
You offer a solid point though. 1.2 million dollars might not be enough for some to retire. Personally, I’m more interested in generating cash flow in a more passive manner. I feel that’s a more sensible yardstick to a comfortable retirement.
Aury (Thunderdrake)´s last blog ..How To Train Your Dragon – The Review
It’s realy hard to know how much to save for retirement, there are so many factors involved.