Mastering the challenge of retirement

There are many theoretical approaches to retirement funding. If you ask a 50-60 year old their strategy, you will get a very different answer than to ask a 30 year old FIRE (Financial Independence Retire Early) person about their strategy. Much has to do with willingness to take on risk. I investigate these different approaches and why both are fundamentally flawed and present a simple answer that I have used successfully.

I recently had the opportunity to sit down with a gentleman who had retired and was in his 60s.  He told me something I knew, but I needed to hear it from him.  That in order for him to get any form of cashflow to fund his retirement, he had to take his hard earned savings out of conservative and low risk investments and put them into the stock market.

In a world where banks have forced down interest rates to very low numbers, it is hard to find any bank that will pay more than 2% interest on savings.  These are banks with FDIC insurance so that in the case of a financial disaster, a run on the banks would allow depositors some level of security.  It was only 10 years ago when we saw major financial institutions including Lehman Brothers, Washington Mutual and Bear Stearns collapse, and we cannot afford to have short memories.

So while those that want to borrow money and incur debt might enjoy a lower cost of access to money, the assumption is that they are working and earning income to be able to service that debt.  Someone who is looking to retire doesn’t want to carry debt into their retirement, since the entire goal is to not have to work.  Debt is the antithesis of retirement.  Debt could be used as a tool to gain assets that could then generate income (e.g. rental property), but that debt needs to be cleared before anyone should consider leaving the workforce and giving up the earning of income based on selling their time.

Let’s do the basic math here.  We should start with an endpoint that has some hedge for inflation.  The location of where you choose to retire matters, because the cost of living in a country town is going to be far lower in terms of real estate costs than an urban city.  If you have the option to take property that you have equity in, sell it and buy in a cheaper place, you could take the delta between sale and purchase, less any taxes, fees, etc. and add that to your nestegg.  That should be considered a one-time event though.  The reality is that we all need a roof over our head, and to consider your house as a part of your net worth only works if you don’t need it to survive.  If you do need it to live in, then it isn’t an asset unless you can exchange it for something cheaper and pocket the difference.

So with that said, let’s say you choose to retire to a place where you need $50,000 a year of income to live.  Over time that $50,000 is going to have less and less efficacy as inflation erodes what it can afford you, but for simple analysis let’s just go with $50,000.   That might seem like a lot of money to many, and may seem like a very small amount to others.  You have to determine what makes sense for you, but with just over $4,000 a month of income the assumption is that all of your costs are paid off.  That may be naïve because things like motor vehicles only have a 5-10 year shelf-life and need to be replaced and often are $20K+ costs.  One must have a strategy for replacement without having to dig into your assets to pay for that.  The costs of food for a couple in their retirement, in which they have more available time, and may prefer to eat out with friends, etc. could require a $500+ monthly budget.  The cost of healthcare, assuming that there is some delta between needed healthcare and what might be available due to the premiums or taxes you have paid over your lifetime into a socialized medical system has to be considered.  Utility costs of power, heating, cooling, gas, etc. have to be considered.  The cost of petrol to run a car, or the additional cost of power to power an electric car have to be considered.  Travel may be something you do more of since you have more time to do it, so the costs associated with that have to be added in.  It doesn’t take long to blow the $4K per month.  And that is assuming you have paid off your home first.

The thing is how do you make that $4K per month?  Are you relying on social security or a pension to make up the lion’s share of that?  If so, and you have that locked in, you are probably safer than most.  But we must all admit that the threat to remove the entitlements of social security and Medicare are real and the math doesn’t lie when it sees it as a potential risk to bankrupt a country.  If you are considering to have a life expectancy that exceeds 20 years from the date of your retirement, you should be very concerned about how the world might look post 2030.

Here’s the key part of this equation.  If you put the money into low risk bonds, or savings accounts with a 2% return, you would need to have saved $2.5 million dollars to yield (safely) $50,000 at a 2% return.  How many people have that?  I’d suggest 1% of the population.   Yes, you would have to be a multi-millionaire to get a measly $50,000 per year income from investments.  Even if you owned a mansion and sold it to live in a condo, you are probably not going to net a $2.5 million gain there.  And even if you put a massive amount of your income into 401K savings, the ups and downs of the stock market over time wouldn’t likely have generated you that level of asset value.
So why is it that so many of the younger FIRE community believe that they can do this with an aggressive 4% withdraw rate on a smaller asset base?  Because they were not likely saving prior to 2008.  Anything after 2008 was a bull market unlike much of what the USA has ever seen.  And that the levels of the Federal Reserve using low interest rates to boost investment in equities has meant that those invested in the stock market would get far higher returns than normal.  Well done, you’ve made a lot of money.

But the day that you choose to retire, your goals entirely change.  You can’t afford to take on risk anymore because you are no longer earning money.  You get conservative with money really quickly.  Can you sustain the loss of 50% of your portfolio because of an economic collapse?  You are all probably sick of hearing about that, but the reality is that we had economic collapses in 1987, 2001 and 2008.   That’s recent memory.  You are looking to retire for 20+ years.  That puts those three events within the timeline of your retirement.  You can’t afford to lose your savings like that, so you will go with conservative investments.  
And that is where my conversation with the 60 year old retiree got scary.  He told me that in order for him to earn enough money to survive month by month, he had no choice other than to invest in higher risk products.  Stocks mainly.  That’s not a recipe for a happy retirement in my mind.

What’s your strategy?

About 50% of the people I talk to, when this topic comes up, do the ostrich thing and stick their heads into the sand.  They have no real plan.  They are relying on social security paying them $1500 a month and hoping that it will be around when they need it.  But at that rate, they can’t afford to fund their healthcare deficit and their cars.  They need other forms of money.  Many dipped into the equity in their homes and don’t have that much if they were to sell it and try and invest the proceeds.  Most are not considered financial experts, so they give their assets to an asset manager to invest for them, thinking that Jim the asset manager or broker will not steer them down the wrong path.  Naivety at best;  negligence at worst.

Maybe a combination of a return on their 401k or a draw down over time plus social security or a pension will do it.  That’s fine, but is that a long term strategy that will hold up?  You’d need to have an awfully large amount in a 401k and realize that over time its return will go up and down with the markets.  I’m not sure I’d be inclined to bank on the long term stability of that approach.
And let’s face it - $50,000 might work today, but will it work in 10 years or so?  The one thing that is true is that the value and efficacy of $1 is being eroded.  By pumping more money into the money supply, each dollar has less buying power.  Things will get more and more expensive.  Prices will go up.  You can take that to the bank.

It would make the most sense to spend some time to imagine your life not working, and what you would need to get through each month.  But to do that analysis based on the initial costs needed at the time of retirement, but then project out 10 or 20 years ahead and consider what you would likely need then, based on a rate of inflation that exceeds what the central banks may tell you is the current rate of inflation.  More dilution of the money supply means less buying power, and more inflation.  I don’t think we are looking at a hyper-inflation problem like in Venezuela but we are likely looking more at a 5% inflation rate.

The challenge

We all need to create a mission that allows us to generate money and thrive without us having to sell our time or labor in order to create it.  That is what retirement is.  You are too old to work – or you are not capable of doing the same work you did earlier in life, or you choose not to work.  Whatever drove you to the point where you gave up work, the results are the same – you need income that adjusts for inflation to provide you a way to continue your life in our society.

You need to establish the number per month you need to survive.  Then you have to find a way to make that money (ideally using a diversified approach to allow for adverse events that may impact it), so that you are not downgrading the quality of your life as factors outside of your control come into play.  That could be government monetary policy, theft, increased taxation, inflation, life events, etc.

That’s the mission.  Now how are you going to do it?

The answer

Once you establish a number that is your target, you have a bit of time to work out how to get there.  But doing nothing is the one guarantee of failure.  Putting your faith in third parties to cover it for you might have worked for generations past, but there is little guarantee that it will work for the future.  So you need to be your own government and your own social security department and you need to start to think for yourself.

This is where financial sustainability is your answer.  By investing in assets that generate dividends and diversifying your approach, you can probably create a solution here.  I believe the core of it should center around rental property real estate.  This is because regardless of the ups and downs in life, everyone needs a roof over their head.  Everyone needs shelter from the heat or the cold and the first thing that people budget for (typically) is their rent.  If you have used the gift of low interest rates to fund mortgages in investment property, and you have not squandered using your tenants to pay down your debt to the bank, when you finish your 15 year mortgage, you own the property.  You own the means of income generation.  Sure, this takes courage, learning and time to master.  You probably won’t make a lot of money on your first investment property.  But considering the equity appreciation, cashflow from rental income and tax advantages, in my opinion there are no better vehicles that can support a retirement strategy than rental real estate.

But you need to do this at scale.  One property won’t cut it.  You will need 10.  If you work hard at having good credit, and you are someone who learns how to master real estate, you can scale this.  By doing that, you could be generating $1,000 per property of positive cashflow, 15 years after you start using low interest rate mortgages.  If you have 10 properties, then there is $10,000 per month of income.  If you build systems to manage them, then it doesn’t take a lot of your time.  And guess what…  Rents go up with inflation.   As does equity values.  If you get to an age where you decide you don’t want to keep managing the properties, then either put them in the hands of a property manager and still get the income, or sell them and liquidate the winnings.  You will pay tax when you do that.  But at long term capital gains rates which often are far lower than regular income rates.  

I see no other option, really.  You could put your faith in the stock market, but for me that is a bridge too far.  You could put your faith in social security or a pension, but that’s a vote of confidence in government knowing the debt load in the USA and that at some point the bill will come due.  You could live in the illusion that “magic money” from central bankers will make you whole, but they only serve those that need debt and pay them for the use of that capital.  That works great when you are building up assets (ie. Buying income producing real estate), but it doesn’t work when you just want a safe return on investment.

The summary

If you act like the ostrich and put your head in the sand, you won’t solve this problem.  If you don’t take advantage of low interest rate mortgages that are available today, you could find it harder to begin the process of buying income producing assets.  Remember you need 15 years to pay them off, and maybe you have to fund a deficit for a while with your pay check.  But isn’t it better to invest in your own assets every month along with your tenants paying down the mortgage, than it is to put money blindly into a 401K fund that may not be there when you need it?

If you have the gift of earning money today, then don’t squander that.  Earn money, invest it into your own assets and use time to build up and scale a portfolio of income producing real estate (and possibly other assets as well), that will be there when you need them.  If you don’t start that today, you won’t get to where you need to be.  15 years minimum time is required to pay them off, and since you probably need to do this at scale, think more like 20 years.  

What will your life look like in 20 years?  Will you be looking in the rear view mirror then, chastising yourself for not doing this 20 years prior?  Will you be the one without the chair when the music stops?

Real estate is, in my opinion, the best way to guarantee income in your retirement and considering that your tenants will pay you to generate your own portfolio, it is the easiest method to use for creating millions of net worth.  Nothing is for certain, but I’d bet on it more than I would bet on social security being there when you need it.  That’s me.  You do you.