The famous dialogue between F. Scott Fitzgerald and Earnest Hemingway is subject to much nitpicking as to who said what, but supposedly Scott said, “the rich are different from us…” and Hemingway replied “Yes. They have money.” So to paraphrase, we might say, “those with more than an adequate sized retirement account are different. They have money.”
Thanks to the proliferation of 401(k) and other employer-sponsored, voluntary, portable, retirement savings programs, American workers have what McKinsey and Company once estimated was four times the value of retirement wealth otherwise achievable through a patchwork of traditional pension plans.
I wrote a column earlier this year making the case that retirees should consider spending more in retirement — a popular column judging from the response. By comparison, common advice related to retirement spending includes some version of the “bucket strategy,” whereby you leave enough cash on hand to pay for the first two years of expenses. Then you invest conservatively to fund the next 10 years, and finally, you invest aggressively given what could be 20 or 30 years of compounding to fund the expenses anticipated later in life. It’s way too complicated.
Another perspective is offered in a recent Wall Street Journal article by Meir Statman, a finance professor at Santa Clara University and author of “Finance for Normal People.” He offers an unorthodox approach to both accumulating and spending retirement assets. It starts with an assessment of how badly we don’t want to wind up poor, and balances this with how much we want to be rich. Not being poor is defined as having adequate retirement income. Examples of being rich would be the ability to pay off college loans for children, giving to favorite charities or spending on some prudently postponed luxuries.
So, rather than struggling with buckets as suggested above, the thoughtful investor considers what minimum sized portfolio would allow them to avoid feeling poor. Identifying a rough estimate of this number and allocating the amount to a conservative mix of stocks and bonds will generate income which, combined with social security, should provide adequate income while still growing to keep pace with inflation. For example, a 50/50 mix of bonds and large-cap value stocks has an historical return of around 7.5 percent per year over rolling 10-year periods. This would allow an annual spending level of about 5 or 6 percent of principal (largely interest and dividends) with the dollar amount calculated at the start of the year and deposited monthly. Five or 6 percent income still leaves capital gains of 1 to 2 percent in the account — creating a cushion and protecting against inflation.
Start by estimating the minimum amount of required income beyond social security that would create a minimalist life style. At 6 percent, a $500,000 account balance will provide $30,000 per year — $60,000 from a million of principal, etc. Having set aside that amount, or with a plan to accumulate it, the balance of the portfolio can now be invested more aggressively to benefit from the so-called “risk premium.” This is the additional average annual return typically generated by an all-stock portfolio. The “risk premium” (an additional 2.5 percent of all stocks over 50/50 stocks/bonds ) is so-named because it is the “invisible hand” of economic forces that, over time, pays investors a financial reward for enduring fluctuations in asset values. Without this force of human nature, there would be no incentive to invest in anything involving risk.
Because the “rich person” objective involves spending (or giving) when circumstances permit, there is no specific deadline for spending the money. Considering that the stock market tends to average about 10 percent per year over rolling 10-year periods, a charity might have to wait for five years for the market to correct before it receives its windfall. Helping to pay off tuition debt also can wait. But with a major stock downdraft impacting this “rich person” portion of the portfolio, it may help to recall that the average “snapback” in value has been substantial once the tide had turned — an average of 39 percent in the first 12 months following the eight market bottoms we’ve endured since 1970.
In any case, whether stock market performance has created a surprise value increase, or because we foresee modest spending requirements in retirement, we may be able to label a portion of our asset mix as the “rich person” segment. In a manner of speaking, “that part is different. It has money.”