When I was still a young buck out in the workplace, financial magazines periodically published worksheets for calculating when you had enough money to retire. The process became much easier when we got our first PC. Programs like Microsoft Money had a retirement planner tab where you entered your personal data, and the program did the calculations for you.
For many years, financial planners considered four basic numbers to be conservative estimates:
- Return on your portfolio: 6%
- Inflation: 2%
- Age your money needed to last to: 120 years old
- Percentage of your portfolio to invest in the stock market: 100 minus your age at retirement
Once you stopped working, you could live off of your nest egg, plus any retirement pension, for the rest of your life. If the computer program said your money would last until your 120th birthday or longer, you were home free. The first time I plugged in my information, it said I could retire immediately – as long as I died before I turned 72. That was when we started seriously socking money away for retirement.
The final number on the list was part of a conservative investment formula. If you retired at age 65, then 65% of your nest egg went into CDs and high-quality bonds, with a locked-in 6% return. The other 35% went into the market. The formula worked well for my first few years of retirement.
That all blew up in the fall of 2008, when the first TARP bill was approved. The banks took their newfound money, paid off debt, and called in their CDs. At the time, our CDs yielded 6% on average, a rate right in line with our overall retirement plan. Today, the best rate for a five-year CD is around 1.8%.
Had we continued to follow the old paradigm and kept 65% of our portfolio in these traditionally safe investments, the income from that portion of our portfolio would have dropped by 80%. Moreover, interest rates are not budging. The Federal Reserve has made it quite clear that it intends to keep interest rates this low for years to come.
The burden of low interest is only made worse by inflation. Planning around a 2% inflation rate simply won’t work anymore. Frankly, the federal government is lying to us about inflation, which is an issue I’ve addressed before. Shadow Government Statistics reports a current, 1990-based alternate inflation rate of just under 6%. Of over 3,000 responses to our recent inflation poll, 34% believed that inflation is 6%-8%.
You may think these figures are high, but they are much closer to reality than the government would have us think, based on the sad little 1.7% boost our Social Security checks received this year. If you’re going to plan for 2% inflation, you should also plan to sell your home and move into your kid’s guest bedroom, because that’s where that plan will get you.
In a nutshell, since 2008 the yield and inflation estimates for retirement planning have reversed. Yields on traditionally safe investments are actually below 2%, while inflation is much closer to 6%, depending on whom we choose to believe (when in doubt, check your credit card statements).
But frankly, it is the fourth figure – “100 minus your age” – that will guarantee too many retirees run out of money much too soon. Keeping a major portion of your portfolio outside of the market in investments that do not even keep up with inflation is foolhardy. Our golden years can quickly become a nightmare of poverty if we are not careful.
The only number that still makes sense is the age your money needs to last to – 120 years old. As life expectancies increase, it’s becoming more and more important to plan for a long life. But if you run out at 119, the hell with it.
Thriving under the New Retirement Paradigm
Unfortunately, the new retirement paradigm is more complicated and harder to define. Let’s start with yield on your portfolio.
The government is printing money at lightning speed. The rate of inflation is increasing, turning the rate of return sufficient for retirement into a moving target best described as “enough to keep up with inflation and provide income to supplement Social Security.” If it does not, you will become poorer every day, and eventually your nest egg will be gone.