That assumes the $800k earns zero interest while you’re drawing $40k per year. You should be able to buy a $40k/year annuity for significantly less than $800k.
Heck, with an 8% return it would take less than $400k, even at a puny 4% it would take less than $544k.
<< has anyone seen any recent estimates of what the average person will need to retire on? >>
Best bet is to talk to a financial planner about that.
If you’re mathematically inclined, you can work up your own spread sheet. You’d make a bunch of assumptions, for example, about cost of living increases each year.
You might make some assumption about your income needs; if the kids are grown and done with school, and the house is paid off, etc etc, you may need less in retirement than you do now. However, I’d be careful with that; while you probably need less to live on at age 60 than you did (ignoring inflation) at age 40, I’m not convinced that you need less at age 65 then you did at age 60.
For a male, figure that average life expectancy at age 60 is to live another 19 years (to age 79); for a female, to live another 23 years (to age 83). If you’re doing serious financial planning, you don’t want to run out of money at age 84 just because you lived longer than average. If you’re only playing around with estimates, then these ages work fine.
And there you go.
When you’re talking about a long interval, like 20 years, and assuming a reasonable interest rate, the difference in payout between exhausting capital at the end of the 20 years, and the payout just drawing at the interest rate into perpetuity is fairly small. I just figure I’ll retire when I can live on a reasonable drawdown from investments, like 5-7%, and not worry about how long I’m going to live.
Ahhh, 401(k)'s what an exciting topic. 
Some advice. If you have at least a 10 year planning horizon you should consider something that has a high rate of return (and also high risk). Then the assumption of an average of 6% and even 8% rate of return is low. Think 11%.
Also, try not to borrow against it as you are now taking that money out of say an 11% rate of return and moving it into a lower rate of about 6-8%.
I am assuming nominal terms here so if you want to think in real terms subtract off say 2-3% for inflation.
Kesagiri: << If you have at least a 10 year planning horizon you should consider something that has a high rate of return (and also high risk). Then the assumption of an average of 6% and even 8% rate of return is low. Think 11%. >>
With all respect, I profoundly disagree.
If someone is making an assumption about future financial performance, that assumption will affect their planning, which could affect their life. No one can predict rates of return (ignoring low fixed-rate investments.) The assumption of a constant growth rate is meant to reflect the fact an AVERAGE over the period one is working with.
If assets out-perform the assumption, you will have more money than you expected and be happy. If assets under-perform your assumption, you will have less money than you expected and could potentially be miserable (depending on how close you’ve cut your margins.) I think it is far better to estimate conservatively and be pleasantly surprised.
I would not let market performance of the past few years be an undue influence, but that depends on one’s time-frame. A 10% or 11% growth rate might not be bad for the next few years, then cut back. But I’d sure as hell hate to have my retirement plans smashed because I’d made an unrealistic assumption about long-term future growth.
I do concur with kesagiri, don’t forget the impact of inflation. THe numbers that you get sound outrageous in today’s terms, but they’re in future terms. Heck, back in the late 60’s, college education cost about $5,000 a year at the most expensive schools. There was a PEANUTS joke from that era about how costs were rising, haircuts were up to $1.50, and Charlie Brown laments that at this rate, haircuts will soon cost $10… and it’s a joke, that would have been an outrageous amount for a haircut. So, if your planning indicates that you’ll need millions of dollars to retire, remember that by that time, a simple haircut will probably be around $100.
[Edited by CKDextHavn on 09-15-2000 at 07:14 AM]
CKDextHavn,
I agree that inflation sure dilutes what one’s nestegg will really be worth.
I remember in “It’s a Wonderful Life”, George is taken quite aback when he’s offered a $20,000 position with Mr. Potter. Quite a fortune back in 1946.
Which reminds me of a little historical tidbit: George Washington, when president, threw a semi-official party at his Mt. Vernon estate, and billed it as an official function. Cost of this party, over 200 years ago: $25,000! Even today, that would still be quite a party; back then, whew!!
This is true that we can’t predict rate of returns, but we do have historical measures, and the rate of return for the S&P500 for the last hundred years has been right around 11%. When you take out inflation, you are talking about a real rate of return of somewhere around 8%. And, if you consider that we are more productive (due to technology) the nominal rate of return may actually be going up.
Yes, if you need the money soon (in less than 10 years), I would question investments that are risky. If you don’t need the money for a long time, I would question low-risk investments. The amount you lose on compunding is staggering.
Finally, don’t forget that even when you retire, you still need long-term investments. If you retire at 65, you will likely live for at least another 15 years and possibly another 30.
For more, visit the Motley Fool website - they have great discussions about this very topic. http://www.fool.com
Brian
Well, all I can say is that I would rather be wrong by having assumed 8% and earned 11%, than by having assumed 11% and earned 8.
Also, most companies with defined benefit retirement plans (where they’re on the hook to make up any poor investment returns), use assumptions in the 7% to 9% range. If that’s what multi-million dollar pension funds think are reasonable assumtpions, I’ll not try to pretend that I can out-invest them.
Some of the choice of assumption, of course, depends on your particular situation. If you are a risky investor who has been very lucky, of if you’re building your own business, you might assume your assets will grow at a rate different from the use of a conservaitve investment manager.
Oh boy…
Yes, when you are socking money away, you would probably do best to assume a low rate of return so that you over-invest for retirement. This is more of a personal thing, because you must balance the needs of the present against the needs of the future.
However, when it comes to picking a plan that you should invest in, if you pick a plan where the goal is to return 8%, you are going to be hurting yourself. You can go to almost any financial planning website and find that the biggest mistake that retirement savers make is that they pick low-risk plans. Note that I am not advocating picking the riskiest plan, but merely picking one that mirrors the market - i.e. an S&P500 index fund.
There’s a huge difference between a pension plan and your retirement plan. Let’s assume that you are about age 30 and you have 35+ years to retirement. You have plenty of TIME for market fluctuations to balance out and give you the long-term average of that 11% return. Pension plans, however, have to pay out benefits every year. In essence, they are in the situation that you would be in in about 35+ years. At that point, it doesn’t make as much sense to be invested in something that is as sensitive to market fluctuations. (Some would debate even that point)
Also, pension fund managers take fees to pay themselves. Would it surprise you to learn that if you added their fees to the return that they generate, you get back to that 11% return? Unless you are paying yourself a fee to manage your own account, odds are that you should expect to beat most fund managers - especially over the long term.
Personally, I don’t think investing in a fund that mirrors the market qualifies as being risky. It’s not like you are trying to outperform the market - you are merely trying to mirror its returns. Yes, in the past few years, you would’ve been extremely lucky and racked up big gains. In the early 70’s, you would’ve lost about half of your money. That’s why you need a timeframe of decades, not years.
Conservative investments are for when you are near retirement, or even better, in retirement.
Brian
I don’t think we’re in disagreement here, bpaulsen. Please note that I am not advocating a conservative STRATEGY for investment; I am advocating conservative ASSUMPTIONS for purposes of financial planning to retirement.
It’s the difference between budgeting and actual performance.
One’s investment strategy certainly depends on age, time frame, risk tolerance, etc. I quite agree, I would not put my money into fixed 8% return. (Actually most of my money is in fixed 15% return, which is another situation altogether, and go ahead, tell me I’m wrong.)
But the question asked earlier in this thread was, “How much do I need to have at retirement.” I described a process for figuring out that calculation, and I chose 8% as a reasonable ASSUMPTION for long-term investment return. I think that assuming an 11% average annual rate of return over a 20 years period is going to lead you to overly optimistic projections. Again, I am not saying to invest your money at 8%; I am saying to estimate your future economic life on the assumption that you will earn 8%.
My whole point was to project conservatively. NOT to invest conservatively, mind, but to PROJECT conservatively. Again, like budgeting. That way, if you do better than your projections, you can retire earlier (or live better after retirement); while the other direction leads to unhappiness (or worse, to a retirement that runs out of money.) My focus has been on 20 or 30 years before retirement for investment AND 20 or so years after retirement for living off those investments. So my assumption has been that over 30% of the time frame we’re discussing are retirement years.
Yes, your investment strategy leading up to and after retirement should be different from your investment strategy at age 20. That’s fine. I haven’t been talking about actual investment strategy; I’ve been talking about trying to do financial planning to project your cash flow needs through the rest of your life.
The idea of accumulating so large a pot of money that you can live off the interest is attractive, I suppose, and certainly attractive to your heirs who can continue to live off the interest. But you can retire on less than that. You can retire under a strategy that eats away your assets by the time you’re 95, say, and thus be confident that some (but not all) of your assets will outlive you.
Not to appear facitous(?) but…
Were you ever sorry you asked a question?
>>I would not let market performance of the past few years be an undue influence, but that depends on one’s time-frame. A 10% or 11% growth rate might not be bad for the next few years, then cut back. But I’d sure as hell hate to have my retirement plans smashed because I’d made an unrealistic assumption about long-term future growth.<<
10-11% would be low if you were using estimates based on just the last couple of years.
Also, most mutual funds under perform relative to the S&P 500 in the long run.