When can I retire part 3: The Live Well retirement calculator
Never Retire Profile of the Week
Alain Ducasse
When it’s safe to travel again, you may want to include a stop at one of Chef Alain Ducasse’s many fine dining establishments. The 65-year-old “Emperor of French Cooking” has over 30 restaurants around the world and has earned an astonishing 21 Michelin Stars over his gastronomic career. No longer working in the kitchen – in some cases banned for his fussy and obsessive interfering – the eccentric chef now oversees an empire of restaurants, cooking schools, cookbooks and consulting activities, which together earn tens of millions in revenue each year, and also works with the European Space Agency to develop astronaut meals. When the pandemic first hit, he was one of very few top chefs to offer take-out at one of his exclusive Paris restaurants. With restaurants throughout France and in Tokyo, Hong Kong, New York, Las Vegas, London many other international locations, consider adding a Ducasse-designed meal to your bucket list before this wonder of the culinary arts hangs up his toque blanche – though it doesn’t look like that will be happening soon.
If you’re like me, you spend a decent chunk of time considering your retirement. Maybe that means planning your future travels. Or selling the family home and moving to the country (or ski hills or beach or mountains). Or turning that hobby into a sideline business. Or sending your grandkids to private school. Whatever your dreams, you want to be able to finance all of its facets and features so you can live it fully and well.
Of course, I also think about retirement because it’s my mission to help my clients and anyone else I bump into to Stay Rich, Live Well and Never Retire. That looks like a contradiction, but those of you who follow my blogs know that by “never retire” I mean “work as much or as little as you like at what you like.” Retirement doesn’t necessarily mean never working. It means doing the work you love because you want to.
So when I talk about retirement, I mean all kinds of things ranging from putting your feet up at your cottage 24/7 to launching a woodworking enterprise from your garage. And I talk about retirement a lot! So here comes more information to help you reach your goals.
In Part 2 of “When can I retire?” I explain that traditional retirement calculators require estimates for inflation, life expectancy, expected returns, sequence of investment returns, and expected pension entitlements. I outlined the difficulty of making long-term assumptions and the consequences of underestimating the required retirement pool on your retirement lifestyle.
In short, if the assumptions are too aggressive, you will overly sacrifice current lifestyle for future retirement years. The opposite scenario may cause you to be more frugal and sacrificing than you want in your retirement.
Given the risk of underestimating your financial independence (FI) number, how do you know you have made the right assumptions? In Part 2, I suggest we adopt conservative assumptions, such as assume inflation between 2-4%, assume investment returns between 2-6%, and assume life expectancy between 95-100 years.
In addition, I suggest updating projections when major events occur, such as a pandemic, a raise, a bigger home, or extended sickness. So the projections are conservative and dynamic.
But is there a better way?
As a certified financial planner, I encounter many investors who are searching for a method of calculating their financial independence (FI) number without making 30 to 50 year assumptions.
Fortunately, I have a unique solution for this challenge of knowing when you have accumulated enough money in your retirement pool to achieve FI. I call it the Live Well Calculator, because I believe it offers a standard of living you can fully enjoy in your later years. Here are the individual parts.
1. Monitor your personal expenses
It is often recommended to focus on what you can control and leave what you can’t. So, what can we control when calculating our FI number? Life expectancy, investment returns, salary, inflation? No. But we can control our expenses. We alone can choose to buy a coffee at Starbucks or brew at home and bring a thermos to the office.
For example, if we decide that our lifestyle expenditure is $50,000 per year, and we assume a 4% investment rate, then based on a perpetuity formula, we need to save $1,250,000 to achieve FI. For some people, this number may be too large and unattainable. If so, it may be best to reduce their lifestyle expenditures.
If we can lower monthly expenses by $1,000, the FI number in the above example is reduced by $300,000. The new FI number become $950,000 and is easier to achieve. (Tip: for every $1,000 reduction in monthly expenses, the FI drops by $300,000, assuming a perpetual formula using 4%). Many investors will find it easier to reduce expenses rather than aim for a higher rate of return by increasing their risk tolerance. The other option is to work longer before achieving FI, but reducing expenses may be more palatable then extending your working career, unless you love to work.
Allow me to demonstrate how frugality can lead to becoming financially independent in 17 years. (Note: if anyone is wondering, I can also make it work in less than 17 years!)
- Assume annual earnings of $48,000 net.
- Save 50% or $2,000 per month, increased by 2% each year to cover inflation.
- Live on $2,000 per month (increased by 2% each year).
- Investment return is 5% compounded annually.
- After 17 years, the retirement pool equals $733,000.
- Begin withdrawing 4.5% of the retirement pool or $33,000 per annum, which is the equivalent to $24,000 of spending in year one. Now you have created a situation of passive income equal to your monthly expenditure, and I classify that as Financial Independence.
If the total portfolio growth minus income is greater than inflation, you will never outlive your money. The retirement pool throws off the inflation adjusted amount you were spending in year one and the capital is never used.
The first rule is to focus on your lifestyle expenditures and not on the many assumptions that are required by traditional retirement calculators.
2. Accumulate inflation-protected assets
The second rule is to spend your working career accumulating assets that generate inflation protected income. For example, many publicly traded companies pay annual dividends and have historically increased their dividend annually at a rate of inflation or higher (i.e. Canadian banks). Another example of an income producing asset is a rental property such as an apartment building. Rental buildings require more attention, but they do offer monthly income and the ability to increase the rents by the rate of inflation or more.
When your assets throw off your lifestyle expenditures (i.e. $50,000 a year), then you are infinitely wealthy. For example, if you accumulate a diversified portfolio of assets equal to $1,250,000 and they generate an inflation protected income of $50,000 per year, I consider this to be financial independence, and it can be achieved at any age.
Another example is an inflation protected life annuity. This asset pays an inflation protected monthly income for the life of the beneficiary.
Just to be clear, I am not selling parts of the asset pool to support lifestyle expenditure: in retirement, you would be living on the income of the asset pool only. If we have the right assets in the pool, the lifestyle expenditures will be satisfied each year and the asset pool value will also increase.
This approach allows you to ignore life expectancy and inflation. Follow this model, and you will be FI when your assets throw off inflation protected income that exceed your lifestyle expenditures. Remember, you can only spend the income that the portfolio generates, hence you cannot outlive your asset pool.
3. Organize and diversify your assets
The third rule is to organize your assets so that the growth rate is greater than the rate of inflation. For example, the total return of the portfolio minus income should be greater than inflation. If the total return of the portfolio is 6% (3% portfolio growth and 3% dividend) and inflation is 2%, you will never have to worry about inflation.
The selection of assets is especially important. A portfolio of bonds will not work, because the capital and the interest income do not grow with inflation and thus eventually devalue your purchasing power.
You also want to diversify your assets, so the income is generated from multiple uncorrelated sources. In a previous blog, I wrote about a client who – against my advice – had all her retirement assets invested in her employer stock plan, which happened to be Nortel. As we all remember, Nortel declared bankruptcy, and my client lost most of her retirement assets. The moral of the story is to diversify assets and reduce the risk of overconcentration.
When gathering income producing assets, think of dividend paying stocks, income producing real estate, business income, inflation protected bonds, inflation protected annuities, and inflation protected government and corporate pension plans.
Avoid investing in stocks that have “big upside” potential but no income, non-income producing real estate such as land, and most bonds.
4. Delay retirement
The next rule is to be very conservative and delay retirement until the income from the portfolio exceeds your lifestyle expenditures. Then, reinvest the extra cash flow back into the retirement pool and allow it to compound over the years to help mitigate the effects caused by black swan events such as the current pandemic or the financial crisis of 2008.
This four-part approach – the Live Well Calculator – does not make assumptions about life expectancy, inflation, sequence of returns, or investment returns. All that is required are a) your current lifestyle expenditures, b) the return of the retirement pool, and c) ensuring the retirement pool grows in excess of the inflation rate.
I know that some readers will compare the Live Well retirement pool with the retirement pool generated by traditional calculators and note that mine requires a substantially larger retirement pool. I totally agree. That’s because the traditional retirement calculator depletes the retirement pool during retirement and is subject to the consequences of inappropriate assumptions.
A hybrid method between the traditional and the Live Well approach may help some investors reach sustainable financial independence. If the FI number calculated by the Live Well Calculator is unattainable because you started too late and or did not save enough money, consider the following hybrid method.
First, divide your lifestyle expenditures into fixed and variable expenses. Take the fixed expense and run the calculations through the Live Well Calculator. For example, if total expenses are $50,000 per year and $35,000 is considered fixed expenses, you will need $875,000 to cover your fixed expenses (assuming 4% investment return). Once you have accumulated this number, you can relax knowing that the family’s fixed expenses are covered and any additional saving (above $875,000) will be used for discretionary expenses.
Too often, I see retirees adopting a scarcity and poverty mindset because they see their retirement pool drop after each monthly withdrawal. As the pool gets closer to zero, their anxiety magnifies. Traditional retirement calculators may prevent a retiree to Live Well – hence my calculator.
This model is amazingly simple: focus on your sustainable spending, not the assumptions required to achieve a certain retirement pool. Armed with this number, search for assets that together throw off enough passive income (after inflation) to cover your spending requirements. That is it!
Did this article resonate with you? What did I miss? Send me a note and let’s start the conversation.
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Call me if you in want to map out how you can Never Retire. You can also subscribe to our Never Retire Newsletter, contact us to order a complimentary book, register for one of our events, and call us to meet with a Certified Financial Planner. We offer you a range of services from a financial plan to investment advice or helping you take advantage of our investment models. Call me at 416.355.6370 or email me at richard.dri@scotiawealth.com.