"The number" -- the amount of money needed to provide a comfortable retirement -- deserves to be revisited after my previous column on the subject several weeks ago. I said at the time that the number was "whatever the wife says it needs to be."
In a new book, "The Female Brain," author Louann Brizendine points out that a woman's brain is "marinated in hormones" that presumably make women talk more, feel more, understand more and intuit more.
Meanwhile for men, whose brains tend to marinate in just a single hormone, here is some hard-wired arithmetic that may be reassuring.
In the early years of retirement, the amount of money in a retirement account needs to accomplish two things. First, it needs to generate income that can be deposited into a checking account every month. Second, the principle needs to be invested in at least some assets that can continue to grow with inflation.
To take a simple example, let's assume that we divide money equally between bond funds and large-company, value-oriented stock mutual funds. While the bonds historically would have made an 8 percent return and the stocks a 10 percent return, let's get real and look at what is available today.
New 10-year bonds are paying about 5 percent, which says that lenders, in the aggregate, think that this is a reasonable return that protects them from the next 10 years of inflation and gives them what is called a "real return." Stocks, by comparison, have had a terrific run over the past three years and are again currently at their highs of 1999. We might expect an average of 8 percent over the coming years if we wanted to be conservative.
If a mix of bond funds includes a short-term corporate bond fund, a GNMA fund and a High Yield Corporate bond fund, the average interest rate or annual yield from all three combined would settle at around 6 percent today. A large cap, value-oriented stock fund, such as Vanguard's Value Index fund, is currently paying a dividend of over 2 percent per year.
This allocation or mix of funds would generate an average income of 4 percent. In a simple example, if we had a total of $10,000 split 50/50, the $5,000 of bonds earning 6 percent would generate $300 a year. The stocks paying dividends of 2 percent would yield $100 per year. The total of $400 per year translates to 4 percent and represents what is called the "weighted average" rate of return. If the above retirement account has $1,000,000, the 4 percent average return would be $40,000 per year. This is "free cash" from interest and dividends that could be automatically contributed into a checking account each month while the principle remains untouched, with the stock portion still growing.
But what about inflation or just the need to have more money to spend? For this, we would consider selling some of the stock side -- periodically. In this example, we have $500,000 in a stock fund appreciating at 6 percent per year (it started at 8 percent, but 2 percent of the 8 percent is the dividend we are already spending.) This 6 percent gain amounts to $30,000 a year. As a start, we should leave this in the plan to protect against inflation because inflation averages 3 percent and the $30,000 of gains on the stock amounts to 3 percent of the entire $1 million account. What a bummer. We're just treading water. Can we spend some of what is on the stock side?
It depends on what else you have that might offer protection against inflation.
If you own a home you plan to keep for awhile, that investment offers at least some of your inflationary hedge. For some longtime working couples, the Social Security benefit of as much as $30,000 a year is equivalent to having $500,000 in a bond fund earning 6 percent. Taking this element of security into consideration, we could make the case that we have $1.5 million in value and maintaining half in stocks would bring the stock fund up to $750,000. Under these circumstances, 6 percent on $750,000 generates $45,000 and taking $15,000 from the stock fund principle each year still leaves enough ($30,000) to protect against the 3 percent inflation on the original million.
The Social Security benefit has its own inflationary hedge with its CPI increases. All these figures starting with $1 million are linear. Having $500,000 or $250,000 means you divide the income figures by two or four, respectively.
In support of that female "sixth sense" these are some real world calculations that, while not perfect, at least attempt a rational, conservative glimpse of what retirement finances might look like. To use them is like stopping to ask for directions.