Early retirement: Not so Unthinkable
10 Jun 2002 16:45
By FundSource
Let's face it. Your recent international equity portfolio is toast and there's no golden parachute in sight. Still, you dream of retiring early -- a goal that seemed feasible during the bull market stampede. However the mercurial market makes it harder to bid adieu to work when you want. But it's not impossible.
Chances are that Wall Street's rough-and-tumble ride during the last two years knocked the wind out of your international portfolio's sails, and with it those lofty plans to retire rich and ahead of schedule. Or did it?
Whether you meet your early retirement goal depends less on how many crashes the stock market throws out than on whether you make sound investing and spending decisions now. It also depends on how well you tame your expectations about market returns and the life you'll lead in retirement.
Take your best shot
Getting a rough estimate of how much money you need to retire early (loosely defined as anything before age 60) is the first step to figuring out how close -- or far -- you are to hitting that goal.
It helps to make some assumptions about how long you'll live. To be safe, use age 95. From there, figure out how much money in today's dollars you'd like to draw annually from your nest egg. That means estimating what your expenses will be in retirement and what new costs you may acquire as a result of lifestyle changes. Don't forget you'll have to pay for health and life insurance policies unless your employer offers you free retirement coverage.
You'll also need to be realistic about how much you can save and invest each year. Obviously, the more, the better. If, for example, you want to retire in 10 years and have nothing saved, you'll need to sock away at least $64,000 a year for every $1 million you hope to have by the time your colleagues throw you a goodbye party, assuming a 7 percent annual return.
Finally, figure out what other income, such as superannuation, you'll have coming to you and at what age you'll start receiving it.
A nasty word to keep in mind
Remember, too, you need to account for inflation. That's because $1 million when you retire will buy less than it would today. So, if you want the equivalent of $1 million based on its current value, your account balance should amount to far more at retirement. Historically, inflation has risen approximately 3.3 percent a year, but to be safe you might assume 4 percent. If your portfolio can generate an annual 8 percent return, that means you'll net about 4 percent on an inflation-adjusted basis, before taxes.
To ensure that you don't outlive your money, plan to withdraw no more than the inflation-adjusted return. That means if you net 4 percent, you shouldn't withdraw more than $40,000 a year for every $1 million you have.
So when can you call it quits?
OK, so maybe the numbers in your life don't add up to retirement at 50. You still have a few options before tabling your dream. For example, you can:
Jack up your savings.
Yes, this is easier said than done, but if early retirement really is a priority, you can find expenses in your life you're willing to cut. The best strategy, of course, is to purposely NOT 'keep up with the Joneses'.
Postpone early retirement.
If you have any sort of doubts, work another year or two. The extra contributions to your retirement savings can make a huge difference to your long-term economic well-being.
Work part-time in retirement.
If you plan to retire early but are worried about your standard of living, you can always seek out consulting work or a part-time job that doesn't cramp your style. Whatever you earn you don't have to pull from your nest egg. If you make just $25,000 a year for five years, for example, that means $125,000 of your portfolio will grow undisturbed. As a result, in five years, you'll have an additional $50,000 at your disposal, assuming a 7 percent return.
Let it go
Whatever long-term strategy you choose to employ, however, there are a few key areas that require your attention today: your attitude and your portfolio.
For starters, treat whatever losses your portfolio has suffered in the past two years as water under the bridge. You can't change the past, but you can learn from your mistakes.
Many people who's portfolios got hammered shared three things in common: they were overexposed to one investing style (for example: growth), one market cap (for example: large), and one sector (for example: technology). They also mistakenly assume high returns were theirs for the asking and based their projections accordingly. People who were banking on much higher returns may find themselves in serious trouble.
Going forward it may be better to err on the side of conservatism. When many advisers work with clients, they paint three scenarios for them: one in which their investments yield a gross annual return of 3 percent, 5 percent and 7 percent. No one knows when you're going to hit a bad cycle.
Over time it's more important to protect yourself from losses than it is to reach for high returns. That's because recovering from a loss requires more in gains than you suffered in declines. For example, if you lose 20 percent of a $100,000 portfolio -- that is, your account balance drops to $80,000 -- you'll need to generate a 25 percent return just to make that $20,000 back (0.25 x $80,000). If you lose 50 percent of your $100,000 portfolio, you'll need to generate a 100 percent gain (1 x $50,000) just to get back to where you started.
Hedge your bets
No, we don't mean put all your money into hedge funds. Diversify! Being well diversified is one of the best ways to protect yourself on the downside. The biggest risk to your entire retirement is concentrated positions.
Since equities offer the best shot at long-term growth, you may want the majority of your portfolio in equities, though how much depends on your risk tolerance and time horizon.
And if you're five years or less from retirement, be sure you have at least three-to-five years of living expenses in relatively liquid investments such as fixed interest, mortgage or cash funds. That way you won't be forced to sell portions of your portfolio in a down market in order to generate income when you need it.
