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May 12, 2009


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Unless you are planning a relativelty short retirement, I disagree with 5 and 6 very strongly.

20x income rule - I agree that expenses is the relevant yardstick. Even then, if you are planning for a retirement of more than 20-25 years, 20x is not enough - inflation, unforseen events, forseen events that simply cost more than expected (e..g. rising health care costs), and a period of below average investment returns make this too risky for me.

4% withdrawal is a very bad idea if you are intenting to spend more than about 15 years in retirement (yes, I know, another rule of thumb). All it takes is for your returns to be below average for a few years in the early stages of your retirement and you will run out of money a lot sooner than you think. Run a spreadsheet with average annual returns which equal your long term expected average return but which show negative returns for the first few years and you will find the result quite scary. Above average returns in later years will not be enough to enable your portfolio to recover.

10% savings is simply not enough. It may (or may not) have been enough in an era where people could rely on meaningful Social Security etc and would expect to be steadily employed for 40+ years, but neither of these can be taken for granted. The real value of Social Security etc has been declining for some time and this is likely to continue. The 40 year assumption also does not work given tbe advent of large student loans which absorb a piece of early savings (delaying the start of retirement savings) and the very real possibility of not having continuous employment for your entire working life.

Number 9 also does not work for me. These may (or may not be) average numbers over a very long period of time (are they?), but there have been many lengthy periods when retruns have been much lower. As examples, interest rates on bank deposits in Hong Kong have been well below 3% for several years and total return on US stocks has been much much less than 10% pa for the last decade. If you were relying on average returns in your reirement years and you strike one of these longer periods of sub-optimal returns you have a problem (especially if you need to draw down principal to meet expenses).

Quite frankly, only 1 and 4 appear to be valid to me (I'll defer to others on 7 as I am not from the US).

2. I still use 100 minus my age. This is not such an old rule for the difference in life expectancy to be 20 years. Plus, a lot of average life expectancy gains factor in lower childhood mortality as well as people who get serious diseases while still employed are surviving longer because of better treatments. In general, though, I think the stock allocation should have more to do with when one wants to retire i.e. how soon you may need the money as well as your risk tolerance. Whatever the rule you should be sufficiently comfortable with your allocation to sleep at night.

5. I don't do much estimating. I am leaning towards using my expenses plus large amount of money set aside for medical care in addition to it. How large? Sometimes I feel I need an extra million here, but this is a bit unrealistic, so maybe half a million?

6. I'd play by the ear here. A lot depends on health at every moment of time.

7. I am maxing out everything; last year I had to use non-deductible IRA instead of Roth with the idea to convert in 2010 - would've been in phase-out if not for capital gains, this year I was in phase-out range thanks to a bit of capital losses so I had to split between Roth and regular IRA. But... For those who have to choose between maxing out 401K or Roth IRA, I'd look at other factors. For example, if your salary is in certain range you may not even be eligible for Roth unless you max out 401K as well. Or without complete 401K deduction you'll get hit by the AMT. Or you plan to move to a state with lower income taxes in retirement. So - it depends.

8. I've always saved more than 10% - I even saved half of my teaching assistantship, but there were years where I used my savings too - e.g. when needed for down payment on a home. At the same time, I'd imagine for lower income family with kids even 10% may be challenging.

9,10. I am very conservative with expected returns; but in general I don't bother with estimates. There are too many uncertainties, the main one is - who knows how long I'll live. I save half of my take home in addition to max 401K simply because I don't need to spend more; but when I really want something (within reason) I buy it. Unless we get hyper-inflation or the market falls 90%, I'll have enough. If I don't - I'll adjust my lifestyle down or work for more years.

My major (err, only) beef with your take is this comment:

"5. I prefer 20 times LIVING EXPENSES. We live below our means and can retire on much less than 20 times our income."

Your living expenses today won't equal your living expenses when you retire. They will do nothing but go up.

I'm in a very precarious position... my mom is 1 year from retirement and my dad is on the verge of death (short timer due to cancer) ... my brother and I have been looking into a retirement community for my mom (not a nursing home! but an apartment/condo for her to stay in with onsite medical assistance for her... after my dad passes).. and the costs are way more than we (and certainly she) ever expected. The cheapest one within a reasonable driving distance with reasonable reviews... was $2800/month (all inclusive). That's about 2.5x what my parents live on today including current medical bills. So, now my brother and I are discussing having her split time living between our houses (thankfully we live about 5 minutes away from each other, and both have spare rooms in our houses). It will increase our costs but not nearly as much as the cost of her living in a retirement community. We figure that she can live with us (splitting time between our houses) until her health deteriorates to a point where we can't take care of her at a satisfactory level.

Anyway... the point of this is that you can't assume that your living expenses will remain the same as you age... if anything, they will only INCREASE as you get older.

I don't get a match on 401k at all, should I be maxing out on a Roth IRA and then concentrate on 401k?

I really like the rule of 72! It's strange how motivating being able to calculate some of these things in your head is!

Rezen --

Maybe, but you don't know what my living expenses today are and what can be cut/eliminated when I'm older. For instance, I have kids (and associated costs like saving for college) -- won't have those when I retire.

But, to be clear, you're right that the "living expenses" that should be estimated are the ones post retirement.

Joe --

That's what most people would suggest.

Rules 5 and 6 are actually contradictory. For the sake of round numbers, assume your target retirement income is $50,000. Rule 5 suggests that you could retire on $1,000,000, but when you start withdrawing, Rule 6 tells you to only take $40,000.

Whatever percent you use for your long-term sustainable withdrawal rate, invert it to get the multiplier for a lump sum. For example, if you assume a long-term withdrawal rate of 4% (0.04, or 4/100), you need 25 times your desired income (100/4). Only having 20 times your desired income implies a withdrawal rate of 5%.

I have researched this matter in great depth and I strongly disagree that 4 percent is a "reasonable rule of thumb" for how much you can safely take out of a retirement portfolio each year. The reality is that the safe withdrawal rate VARIES with changes in the valuation level that applies on the day the retirement begins. At times of high valuations, it can drop to 2 percent. At times of low valuations, it can rise to 9 percent. No one rule is possible because the valuation level is the single biggest factor influencing what is safe.



Rules 5 and 6 are actually not contradictory. However, they do assume that you will not have any "nest egg" left over when you die.

If your target retirement income is $50,000, then you can indeed withdraw that much from your retirement savings. In the meantime, your $1M in savings will appreciate by some amount. Say it's in a CD earning 3%, your savings will appreciate by $30K. So you're really only withdrawing a net of $20K annually from your account (this first year). The net will increase as the years go by, since you have less and less money earning that 3%. And the goal is that by the time you die, you'll be using the last of your money.

I personally would rather just live off of what my retirement savings earns in a year, so I will never run out of money. So in that regard, I agree with you. I just wanted to point out that this rule of thumb does assume you'll end up spending all your money.

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