Reach Your Retirement Requirement

“Just as grown-ups do not believe in the Tooth Fairy, the Easter Bunny, or Santa Claus, ‘Investing adults’ know that there is no such creature as the Stock-picking Fairy or the Market-timing Fairy. Further, there is no Risk Fairy who will write you cheap options that will protect your stock holdings against loss.”

Amazon.com description of The Ages of the Investor: A Critical Look at Life-cycle Investing

William Bernstein; Publication date Aug. 28, 2012

Retirement is on everyone’s mind these days; not so much about how pleasant it could be, but instead how to pay for it. This is especially relevant considering the average salary in the U.S. is almost 10% lower in today’s dollars than it was in 1995. At the same time, the average age of death is increasing.

William Bernstein, a well-known investment guru, has some ideas about how to handle this problem. He verbalized them in his recently published book, The Ages of the Investor: A Critical Look at Life-cycle Investing.

For those planning retirement, the key take-away from this book is tough love — a less-than-easy formula for many. Bernstein says that in order to retire comfortably a couple or individual needs, at minimum, 20 to 25 times the retiree(s) plan to spend each year in retirement minus Social Security and any pension return. In other words, the gap between what someone receives from presumably solid sources (Social Security and pension) and what they want to be able to spend to continue their lifestyle can be made up by that figure. He says the equivalent of, “Put it in riskless investment. It is what you can’t afford to lose.”

For example, 61-year-old Jane and 65-year-old Bob have $1.5 million put away. They want to be able to spend $100,000 per year in retirement and they expect to receive $50,000 together from Social Security and pension payments. Bernstein recommends that they have 20 to 25 times $50,000 in riskless assets for this purpose. In this case, the minimum (20 times) would be $1 million.

This is where Bernstein gets tough, but only because he is realistic. He more or less says that if you want $50,000 per year in retirement income from your investments, but don’t have a minimum of $1 million, then you have to keep working until you do have it.

I find this to be solid guidance. The problem in not having that much of a nest egg is not only running out of money, but also being left short if Social Security and pension returns aren’t what you expect.

Jane and Bob’s $1 million so-called riskless portfolio might include Treasury Inflation Protected Bonds, AAA-backed annuities and short-term bonds. Although the latter aren’t paying anything now, if/when inflation hits they are poised to benefit because their turnover is short. This is the portion of the portfolio meant to cover living expenses (along with Social Security and pension payments).

But, placing 20 to 25 times desired income minus Social Security and pension income doesn’t take into account inflation since Bernstein recommends placing it in generally more secure assets (Treasury Inflation Protected Bonds being the exception). Still, almost every American expects to see the cost of living increase). This means that further monies to invest above the so called riskless assets are a very good thing.

The excess $500,000 that Jane and Bob have is just that — their nest egg for inflation. It might be invested in dividend-paying stocks, which can pump up return while also providing potential for growth. However, if the market plunges unexpectedly, these assets would dive in value too. That is why this portion of the portfolio cannot be counted on for those crucial living expenses like the 20 to 25 times figure. Instead, the money earmarked for inflationary investing is like icing on a cake. It is meant to provide a softer cushion if inflation goes rampant.

For more, please read The Ages of the Investor: A Critical Look at Life-cycle Investing by William Bernstein. It is only 54 pages and can be downloaded or purchased as a book.