Todd Tresidder is a well-known financial coach and founder of FinancialMentor.com and he was kind enough to send me a free kindle copy of his book How Much Money Do I Need to Retire? Today I’m going to share some of my thoughts on Todd’s book.
When most people think about retirement they imagine a specific amount of money they need to accumulate in order to throw off the shackles of their day job and live the life they always dreamed about. They bounce around to some of the many retirement calculators available online in search of the “magic number” that will set them free. But if you have ever actually sat down and tried to calculate your own “magic number” you were probably left more than just a little confused and discouraged.
Why is that?
The Problem with Retirement Calculators
As Todd explains in his book, the conventional way of thinking about retirement planning has some serious flaws. The truth is there is no magic number. It’s just not that simple. You can’t just say “Okay, I’ve saved up $1 million. Today I can retire.”
Retirement calculators are fatally flawed because there are so many variables that are unpredictable, including…
The rate of return on your investments. Sure you can “estimate” an average return of 7 percent but who knows if that’s what you’ll really wind up earning. What if your estimate was too high?
Whether your retire in a bull or a bear market. Those first few years after you retire will have a big impact on whether or not you outlive your savings. One common rule of thumb says that you can safely withdraw 4 percent of your nest egg each year (adjusted for inflation) and there will be a high probability that your savings will last 30 years.
But just because something is probable doesn’t mean it is guaranteed. The sequence of your investment returns can make or break your retirement. I’ll let this snippet from Todd’s blog explain…
“The sequencing of returns problem is best illustrated in this example from William Bernstein. Assume you have a $1,000,000 portfolio with an average return of 10% split evenly between 15 years at +30% and 15 years at -10%. This would give you a compound return of 8.17% (compound is less than average due to volatility effects). More importantly, when you vary the returns sequences you get something truly shocking…
If you are unlucky and start your retirement with 15 straight losing years you can only withdraw 1.86%. Same annual returns, same average return, different sequence of returns, different result.
Conversely, if you are lucky enough to start your retirement with 15 straight winning years you can safely withdraw 24.86%.”
Inflation rate. In recent years the inflation rate has been pretty low. You might estimate the inflation rate at say three percent when you run your retirement calculation, but what happens if we have another period like the 1970s where the inflation rate often went into double digits? Your nest egg will have a lot less buying power and you’ll have to sell off more assets to make up the difference. If that happens, the odds of you outliving your savings greatly increases.
Your retirement age. Let’s say you’re planning to work until the age of 65 and then ride off into the sunset. All of your financial calculations are based upon you continuing to earn a salary and sock away money until your sixty-fifth birthday. What happens when your employer lays you off when you’re only 58? Or maybe you run into health problems and you’re no longer able to work full-time?
Sadly, these type of scenarios are all too common and they can have dire consequences on your retirement plans. If you’re forced to stop working earlier than planned you’ll not only have less time to reach your savings goals, you’ll also have to make you current savings last even longer.
When you’ll die. Online retirement calculators ask you how many years you need your retirement income to ask, but in order to know that you would need to know when you’re going to die. Are you going to die 5 years after your retire? 25 years? 40 years? Your saving needs will vary dramatically based upon how you answer that question but the real problem is that you’re just guessing. Sure, you can predict you’ll live 30 years after you retire but if you live longer you could end up spending your final years broke.
A New Way to Look at Retirement Planning
Todd spends several chapters exposing the holes in the conventional approach used to determine how much money you need to retire. I will warn you that some of these sections are heavy on math and can be a bit difficult to get through, but they’re an important part of the author’s case that conventional retirement planning is flawed.
But then comes the really good stuff where he lays out his Three Rule System which bases retirement calculations on cash flow instead of asset values. This is a key distinction that can change the very way you think about investing and retirement itself. You no longer focus on accumulating the most assets with the intention of slowly selling them off to fund your retirement. Instead, you focus on building cash flow and income streams to support you without ever having to sell your assets.
The key is to build an investment portfolio that throws off enough passive income to cover all of your expenses. Additionally, it should grow with inflation so you can live off the residual income from your investments without ever touching the assets themselves.
This falls exactly in line with my own thoughts about building multiple streams of income. This blog generates income for me (though a pitifully small amount right now) and I’ve also started a Sharebuilder account in which I invest in dividend paying stocks.
While I can’t currently live off the income provided by either of those sources, my plan is to continue building revenue streams until they can support my family with little effort on my part. As Pat Flynn says on each of his Podcasts…”It’s all about working hard now so you can reap the benefits later.”