Wednesday, September 24, 2014

What is a Big Factor in Early Retirement?

One of the interesting things about retiring early or getting a second career, is that  when you create your plan, you immediately see what is most important.  In a previous blog post, I highlighted that you need either a large investment portfolio, or a generous pension - a rare thing nowadays.

This is certainly true, and let's focus on the most likely scenario of a couple retiring early without a large company pension, i.e. they self-finance their retirement.  Ignatz and Myrtle are my example, they want to retire at 56 years old.  They are in good health and want to live on $100,000 a year after they retire.  They expect to get government pensions (SS or CPP) of $22,000 a year.  They have a savings plan that will get them to $2M in savings by the time they are 56.  Their life expectancy is 87 years, but they want to plan for 92 to be conservative.

Let's assume inflation is 3%, is their goal of retiring at 56 feasible?

1. A simple planning estimate based on a rate of return of 5% says that yes, the plan works.  At 4% return, they will run out of money before they reach 92 at about age 86.  They need a rate of return of about 4.85%.  This is computed using a financial calculator annuity function with N=36, PV=$3M, I=1.85% (rate after inflation).

2. Running the Monte Carlo tool at Vanguard covered in a previous blog post gives a more realistic view of things.  With a $2M portfolio of 40% stock, 40% bonds, 10% cash, there is a 82% chance of success.  At 10% stock, 40% bonds, 50% cash, there is only a 49% chance of success.

What this is telling us is:

 Rate of Return is a key factor in a successful early retirement that is self-financed.  

The plan outcome (your life in retirement) is highly sensitive to the rate or return aka ROI.  So, when drawing up your plan or working with your financial advisor, carefully examine the rate of return that is used in the plan, whether it is a simple (case 1) or a more complex analysis (case 2).  If a high rate is used, like 7% or 10%, question how that return is going to be obtained and what is the proof that it is feasible.


  1. I thought I was being overly optimistic with a 4% growth rate on a portfolio, but was told by a few "experts", oh no, 7% growth is normal now. Why does this sound like the 90's again?

    1. Thanks for the comment, your skepticism is well-placed. You will need a high percentage (over 75%) of your investment in stocks to get an average 7% return and this is too high risk for most retirees.

  2. It probably just me --- but I think $100K annual income is a lot! Won't be as much when they are in their 80-90's I understand, but what on earth do 2 90 year olds do with that much income (assuming they are not in intensive care) The majority of people don't live on that much income during their working years.

    1. Thanks for your comment. You are right that $100K is a lot to live on. Two notes: (1) if you change the living costs to $50K and reduce the lump sum saved, the rate of return is still a big factor in the plan. (2) in the USA, the cost of a decent retirement home per month for a couple ranges from $5K to $10K per month.


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