I’ve been reading about retirement lately. One piece of the retirement planning puzzle is figuring out how much money you need.
Let’s make some assumptions, for the purpose of this discussion – your requirements likely will vary considerably. Your annual earnings over your work life average $60K (near the current median family income),
and for ease of calculation we’ll say you earn that $60K both as you start your first job and for every year until you retire.
(If you earn double, then double everything (except the rate of return), and if you earn half, then cut the amounts in half.)
You decide that you’ll be saving 10% of your salary (or $6K) each and every year. You’ll invest it and earn a constant 6% rate of return. We’ll say that once you can earn $54K each year, from your investments, you can retire (100% of what you’ve been living on).
The question is: How many years must you work to reach your money retirement goal?
Let’s work backwards. If you need to earn $54K at 6%, then your nest egg must have grown to $900,000. Putting aside $6K each year, and earning 6% a year will get you to that $900,000 in about 40 years.
This all depends on our assumptions, but it also depends on some items we haven’t talked about yet.
The FED has been debasing the Dollar ever since the FED was created 100+ years ago. Prices have risen every year, except during the Great Depression, a couple of times at 10+% a year. And, the CPI methodology has been fudged, so that the CPI would show the value of the Dollar being only about 1/3 of what the official numbers show. All told, a Dollar today can buy about what $0.01 could buy back in 1913 – that’s about 5% a year compounded!
Instead of 6% growth you would need 5% more, or 11% to make up for inflation (we’ll ignore the inflation take from your salary, since you likely will be getting some raises). 11% a year, every year for 40 years, is nigh on impossible.
Let’s assume you’re an investment wiz kid, and you’re able to beat inflation by 4%, for a total return of 9% a year. Now, your required nest egg is much larger: $1.35Million, and you have to keep working for 59 years (that’s work for 59 years – not age 59). You may want to think about getting a second job!
We haven’t even considered the tax bite as yet. We’ll ignore taxes on the original $60K salary, since we said you’d be able to save 10%. But every time you get a raise, your tax base goes up and you get pushed into a higher bracket.
And, as you start getting investment earnings, they also get taxed. As you approach retirement, the investment income almost doubles your taxable income. You can use an IRA, but be forewarned that that reduces your flexibility; if conditions continue to worsen and your money gets stolen during a Bail-In, you’re totally screwed.
The price to buy the investment varies with the Dollar income stream and with how much you’re willing to pay for those earnings. For stocks, that’s called the Price to Earnings Ratio, or just PE Ratio.
If a company is earning $1 per share, you might have to pay $7, $14, $21, $28 or any other price per share, depending on what all investors expect (hope) the future will hold. (At $7, it will take 7 years to earn back your $7 at $1 a year of company profit. At $14, that’s 14 years, at a PE of 21, that’s 21 years, and at $28, your stock has to earn $1 a year for 28 years!)
I chose those numbers because historically, when the Market PE is around 7 times earnings, the Market is considered cheap, a PE of 14 is the average over the last 100 years, 21 is considered expensive, and a PE of 28 is in Bubble territory. Right now, the PE on the S&P 500 is a little under 20, fairly expensive.
Why this is important is that prices go through up and down cycles. When you buy relatively high, it gets that much more difficult to get high yields – and your 4% over CPI inflation assumption becomes less likely to happen.
Ed Easterling at Crestmont Research puts out several free reports on PE Ratios and other investment topics. He shows what the historic returns have been when the PE started at various levels. Historically, when the PE starts high, the returns going forward are low (or negative); when PEs are low, the returns are higher. Since the PE is high today, you should expect poor returns.
Interest rates have been kept artificially low by the FED, meaning that Bond prices are artificially high. Buy a Bond today, and you should expect poor returns. And, the rising Dollar in Forex markets also is a negative for our Economy.
Taking Taxes, Inflation, and the US Economic Environment into consideration (and there are more negatives!), the chances are good that, even if you doubled your savings to 20% of your salary, you still may not be able to stop working (given our assumptions).
Some people will point to Social Security and say they need less. That’s true today, but likely won’t be true fairly soon. As more and more Baby Boomers retire, the current Deficit in Social Security will be even worse, and the system will be forced to cut benefits or collapse. (The same is true of Medicare.) If your retirement is 20 years down the road, I suggest you not expect a penny from either program – let what you wind up getting be gravy.
The bottom line is that, even saving 10% of your pay (as suggested in the classic “The Richest Man in Babylon”) won’t be enough to retire on. We might be able to make things easier for your kids if we take a scissors to the Federal Government, but chances are that you should expect to work ’til you drop or make do with a lot less in your old age, unless you find an alternative investment which is cheap today, offering more upside potential (I like Gold & Silver, but do your own due diligence).
The bottom line is: Your retirement has been stolen by the awful policy decisions coming out of Washington for several generations.