Money magazine this month has an article titled “How to Reach One Million Dollars” where it goes into all of the myths told about reaching a million dollars net worth before you retire. Some of the myths they included are:
1. To get to $1 Million, you need to start very early. (You can actually start later but just invest more aggressively.)
2. You have to drastically lower your standard of living. (Really, relatively minor changes will work as well.)
3. You have to be a great investor. (You really just need an average return.)
4. You must embrace Stocks, even in your fifties and sixties. (You can actually do more damage and increase your chances of outliving your money by having a big loss late in life because you are too heavily invested in stocks than by giving up return by having too little in stocks.)
Certainly the math is sound and you can reach a million dollars by the time you reach 65 or 70 without being a business tycoon or investing from the time you are 12. The trouble is, however, a million dollars isn’t what it used to be.
A rule-of-thumb is that you can take about 4% of your portfolio value out of your portfolio each year and have a good chance of not having the value of the portfolio decline, meaning it will last indefinitely. The idea is that you can take out this amount and then have the portfolio still grow enough to keep ahead of inflation. With a million dollar portfolio, that would be about $40,000 per year in income. That would probably be enough to pay for food, clothing, utilities, and some medical expenses for most retired couples. This might be enough of an income if you have paid off your home and plan to just sit around, but it wouldn’t be enough to really live.
You would constantly be worried about expenses increasing. You wouldn’t be able to travel extensively or buy many new things. You would also need to invest very conservatively because if you suffered a loss of 20-30% in a bad year in the stock market it might be enough to send your finances into the death spiral where you are using more than your portfolio could replenish. This might mean you’d need to give up some of your hard-earned assets to gain more security through the purchase of an annuity or the use of a reverse mortgage. You would also need to get long-term care insurance to make sure one spouse in a nursing home wouldn’t deplete all of the assets the other spouse needed to survive. In other words, you are giving up income on your money and paying out more in fees and interest than you would if you had more money saved.
Now what if you had $2M in your portfolio? You could invest the first $1M very conservatively in an annuity or a mixture of 60% fixed income to 40% equities. You would therefore have the same protections for your first million dollars as everyone else. With the second million dollars, however, you could invest the whole sum in equities because a 30% decline wouldn’t leave you any worse off than the conservative person with only $1 M. Even though your ratio of stocks to bonds would be different, you would be taking no more risk than the person with only one million dollars because you invested your first million dollars the same way he did. Because you had more in equities, however, you would generate a substantially larger income over time, providing you with more spending money and more security.
If you had $10M, there would be little reason to buy long-term care insurance. The likelihood fo spending even a million dollars in a nursing home would be remote and you would have more than $9M more than you needed for basic living expenses. Likewise, you could drop your home insurance and be self insured if you so chose because replacing a $250,000 house in the unlikely event of a fire would be nothing to you. You could also have two or three houses, providing a hedge against stock market declines and inflation.
So, yes, it is easier to make a million dollars than it used to be, but a million dollars provides nothing like the security it used to. The goal of someone in their twenties today should be $10 M or more, which means you should start saving early and saving enough (10-15% or your paycheck). You should also be making wise financial decisions, such as limiting spending especially during the early years to create an excess for saving and investing and buying a home you can pay off by the time you are in your forties. There is a big difference between saving just enough and saving a bit extra in the lifestyle you will see in retirement because it changes the risks you can take.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
