ExpensesExpenses are an uninspiring but necessary topic in this assessment. Your expenses are an underlying factor that determine when you can retire based on the savings you have. It boils down to the question of whether you can cover your expenses, for life, from:
- Spending your savings
- Income streams
- A combination of these two sources
Lifestyle ExpensesIf you haven’t already, total all your current monthly expenses to see how much income you’ll need to maintain your standard of living. Lifestyle expenses are a factor of how you live. This means you have a lot of control over your lifestyle expenses. Control is a good thing when it comes to our money. We can’t control a lot of factors that affect how long retirement savings will last, but by embracing and controlling those we can, we can change our circumstances. Where you live is one of the biggest influences for expenses, hence the popularity of downsizing. If you live in a 5000 square foot house in an expensive area, you’ll obviously need more money to retire than if you live in a low–cost area in a 2000 square foot house. Read more about this in my post How to Create a Wealth Plan.
Non–Recurring ExpensesAside from monthly recurring expenses, home maintenance and property taxes are expenses that hit us once or twice a year so they’re easy to forget. Here is a video I did on these hidden expenses in seeing how much money you need to retire.
InflationInflation is a scary factor in planning for retirement since it is completely out of our control. The result of Inflation is that you can buy less with the same amount of money. Inflation is why 2 million won’t buy anywhere near as much as it used to in the good old days. Historically, inflation has been about 3% a year but in more recent years, it’s been closer to 2%. There is no way to know for sure how much it will be, but it is safe to plan for at least 2% inflation in my opinion. If this sounds too complicated, no worries; most retirement calculators account for inflation. Here is a video I did on inflation.
Lifestyle InflationLifestyle inflation is another consideration for retirement planning. It refers to the habit of spending more money as your wealth increases. Here’s the thing: If you’ve gotten to the point where you have 2 million dollars, your lifestyle spending has probably risen right along with your wealth. Almost everyone buys more simply because they can. Inflation lifestyle is very real but, unlike inflation, it is under your control, unlike the next factor. Read my related post Is Your Retirement Income Goal Possible?
Healthcare ExpensesEven though I rarely go to the doctor, medical insurance and related health care costs were one of our biggest expenses since we lost our health insurance coverage after Cobra ended from Larry’s employment. For someone retiring at 55, this can be a huge problem unless they are covered under a working spouse’s medical insurance policy. There are many variables around health care costs including your general health, prescriptions, how often you visit the doctor, income taxes, and even whether you have a small business. Since I have been managing this outrageous expense for the past decade, I can safely say that you will want to see how much your insurance will cost before you retire as it can be a deal killer. But there are some strategies that lower health care costs indirectly through lower taxes which I’ll cover next.
Small Business and Health InsuranceIf you have a small business taxed as a C Corp or an S Corp, you have different options vs. insurance coverage as an individual. And most people are familiar with HSA’s (Health Savings Account) as an indirect way to lower health care costs through lower taxes. Again, medical insurance is an important factor, especially for some retiring before age 65. Every year, I spend hours evaluating and selecting an insurance policy while factoring in all these considerations. For example, most years, I buy Frova, the one prescription I take (for occasional headaches), from a Canadian pharmacy. And this year I decided to forego the HSA because the tax savings didn’t offset the increased premiums for a qualified plan. Fortunately, we do have a small business which is now taxed as an S Corp. Medical insurance and healthcare costs are highly personalized expenses, some of which is under your control. As I dealt with health insurance this year, I realized that the health insurance decision triggers a lot of fear for me, and it may for you too, since we all want good healthcare when the need arises. If you’re thinking of retiring before age 65, here is my advice: Talk to a good insurance broker, and a good CPA with extensive knowledge on this topic. There is a lot more to be said about expenses we’ve but I’ve addressed the main factors which we’ve experienced that many overlook. The income numbers we’ll address next is where you can have a dramatic effect on when you can retire. In summary, total your expenses and prioritize them based on your life priorities. The lower they are the more likely it is that you can retire at 55 with 2 million!
Retirement MethodThe old way to retire was to live off social security and a pension for ten or so years until you died. This is how my great Uncle Blake retired from the oil company that employed him for life. But for the past few decades, the more common way to retire is to use a retirement withdrawal method. Two million dollars will go a long way with a retirement withdrawal strategy as you’ll see below. The Boomer generation, in particular, has retired with this strategy. It is based on spending down your retirement savings and hoping that it lasts. The reality is that it may last, but it may not, and you won’t know until it’s too late. Later generations, however, have discovered retiring early with “side gigs”, real estate, and online businesses. This is exactly what we did, but we just did it out of necessity before it became vogue. We saw that stock dividends and bond interest alone wouldn’t support us for life. And since we were only in late midlife, we didn’t want to start living off our savings using a retirement withdrawal method. Nevertheless, the retirement withdrawal method is still the goal of most traditional retirement planning. It can work great for someone with very low expenses and/or a lot of wealth. Basically, retirees withdraw 2% to 4% from their retirement account to live each year. Most retirees adjust this withdrawal for inflation. You can read more about this in my post on retirement withdrawal strategies and Living Off Investment Income – Advantages and Disadvantages. There are several problems with retirement withdrawals which you can see in my video on which retirement withdrawal strategy is right for you.
Retirement Withdrawals on 2 MillionIf you have 2 million dollars in retirement savings and you choose a 4% retirement withdrawal method, you would withdraw about $80,000 the first year, or $6,666 each month.
2,000,000 * .04 = $80,000/12 = $6,666If you plan to use a safer and more modern 2% retirement withdrawal rate, you’d withdraw about $40,000 the first year, or $3,333 each month.
2,000,000 * .02 = $40,000/12 = $3,333This math gives you a good idea of how much income you could expect if you choose to use a traditional retirement withdrawal method and you have $2,000,000 when you retire. Then you’d add social security and any other income streams to the amount you withdraw. Ideally, this will cover all your expenses. You can check to see if it does after addressing the expense issues presented earlier. Note that the withdrawal is made up of dividends, interest, savings deposits, the growth of these over the years plus compounding. Ideally, income (dividends and interest) and compounding will make up most of the withdrawals. This will depend, however, on how your investments have performed, which is largely a function of the economy, another factor out of your control. Read my related post Are Stocks Safe for Retirement?
Income StreamsHaving “extra” income streams is where the magic is. This approach takes a shift from the traditional retirement withdrawal method above to capitalizing on your savings and skills to increase income streams outside of typical stock and bond income. As you saw above, your investment income from stocks and bonds makes up part of your retirement withdrawals. These days, however, a big problem for retirees is that bond interest does not even beat inflation. And the dividend yield from most common income funds and dividend stocks is 3% to 4%. To make matters worse, there may be taxes on the investment income. There is also inflation of around 2% to consider, leaving most investors with a paltry real income of 1% to 2% from a typical investment portfolio. So, you’re probably wondering where the magic is because it sure isn’t here. The magic is in increasing income beyond that typical 3% to 4% with what I call uncommon income streams. This can be done in many different ways. The best way for you will be based on your skills, amount of savings (capital), desired lifestyle, and many other factors. This is explained more in my post The Best Income Stream to Start before Retirement and in the video below.
Traditional Investment IncomeThe easiest way to increase investment income is to seek out and choose higher yielding stocks and bonds. This takes some effort but not a lot. There are financial advisors and fund managers that specialize in high yield investments. One more traditional financial advisor I read about in Barron’s, for example, achieves dividend income of 5% for her clients with a goal of at least 3% capital gains from those same investments. By comparison, some of my wealth coaching clients have been paying higher wealth management fees while in income funds paying only 3.5% income. A 5% dividend yield, as in the financial advisor example above, would allow a retiree to withdraw 4% without even touching her investment capital. And the extra 1% would go toward financial advisor fees. Voila! If 1 million out the the 2 million dollars is in less volatile dividend stocks yielding 5%, the math would look like this.
$ 1,000,000 x .05 = $50,000/12 = $4,166Then, if you invested half the balance in bonds yielding 3%, and perhaps half in an alternative higher yielding investment yielding 9%, you could achieve a yield of 6% on the other million.
$1,000,000 x .06 = $60,000/12 = $5,000Now we see that someone retiring with 2 million using a slightly different approach could achieve income of over $ 9,000 a month while not taking retirement withdrawals from capital. The withdrawals would be covered by the investment income entirely. Read my related post What Are the Risks of Bonds? and Is Dividend Investing Worth It?
DIY Income InvestingIf you prefer to manage your own money vs hiring a financial advisor, there are investment newsletters and financial experts who focus on higher income investments. For example, I subscribe to a service that recommends diversified investments with a 9% income yield on average. Most, but not all of the investments are what I call slightly alternative, such as MLP’s, REIT’s, baby bonds, closed end fund and BDC’s (Business Development Companies). In this service, all the investments are ranked based on risk level. Importantly, valuation is at the crux of the evaluation process they use. And many former wealth managers and fund managers produce commendable recommendations for high yielding investments. These are, after all, many of the same experts who were charging 1% to 2% and more to invest high net worth client money when they were working in wealth management. It’s important to note that the assets that produce the income will increase during bull markets and decrease during bear markets. Read my related post Predictors of Bear Markets and How to Manage Risk in the Stock Market.
Real EstateReal estate rentals are another income investment that can have positive cash flow while also building wealth. They key is to buy properties that do, in fact, cash flow after all expenses. It’s important to note that there’s a little more work involved with real estate rentals than with passive income from stock dividends. With real estate, stocks, and bonds, considering valuations and cycles before buying them is an important part of building wealth outside of generating income. Read my related post Owning a Business Vs Real Estate.
Income from $2,000,000 in High Yielding InvestmentsLet’s look at another example of income off a 2 million retirement account. If you increased the yield (income) on your investments to 7% vs the common 3.5% from a typical income fund, here is the income a $2,000,000 investment portfolio would produce.
$2,000,000 * .07 = $14,000/12 = $11,667/MonthRemember, don’t confuse income with growth, which comes from capital gains, or an increase in value from the underlying investment. The value of almost all income producing investments will go up or down. Read my post Wealth Building Vs Income for more about this. Stocks, bonds, REITs, MLPs and real estate rentals are all fairly common income investments. We like all of these income investments, but we learned there are two more income methods well worth exploring.
Covered CallsIf you own a stock portfolio, you can sell call options against the stocks you own. Contrary to common belief, a covered call strategy does not increase risk from owning stocks. In fact, selling covered calls in stocks you own reduces risk since it lowers the cost of your stock position. Selling covered calls can double, triple and even quadruple the income received from dividend stocks! Income of 10% to 12% in addition to dividend yield is not uncommon for covered call writing. And many financial advisors sell covered calls for their clients, although not many since it is difficult to sell covered calls in high volume. It also takes a little time to manage covered calls. For an individual, the time is minimal, but for a financial advisor, the time can be significant, depending on the number of clients he has. Some funds sell covered calls, but due to the volume issue, the yield is not as good as an individual can get. You can read more about selling covered calls in my post How Do Covered Calls Work?
Online BusinessOnline business are becoming mainstream assets as blogs and cash flowing websites are increasingly purchased by equity and venture capital firms. You can buy a cash flowing online business for a fraction of the cost of a publicly trading company. Alternatively, you can start your own for less than $50 if you want to spend the time. Online business is where I see the best opportunity to make money now from both an income and wealth building standpoint. Read my related post Is It Too Late to Start an Online Business? and Start a Business or Invest in Stocks?
Side GigsThe younger generations are onto something here. For example, (the family of) eight year old Ryan Kaji made $26 million off his YouTube channel and related products in 2019 alone according to Forbes. For heaven’s sake, he got started unboxing (unwrapping) toys in only 2015! (1.) Adding small business income of any type can completely increase your ability to retire at 55 or much earlier. And it can provide good income for current retirees, often with tax benefits when handled correctly. While you may not want to focus on income generation in retirement, many side gigs can bring in $1,000 to $3,000 a month without a lot of work. Doing consulting in the area of your career is an ideal side hustle but there are dozens of other ways to bring in extra income without having to do work you don’t like. For inspiration and ideas, read my article 115 Cool Small Businesses to Start Later in Life. After you read the next section, you’ll be shocked at how generating just another $1,500 a month can affect your ability to retire at 55 with 2 million, or any other amount!
The Impact of an Extra Income StreamLet’s say you’ve tweaked your expenses, and see that you can cover them with a retirement withdrawal of 4%. But since you’re only 55, you sensibly don’t want to withdraw from your 2 million dollar savings just yet. So, you decide instead to increase your dividend income and also create an extra income stream of $1,500 a month from consulting. Next let’s equate this $1,500 a month to the amount of savings needed to generate that same amount of income each month using a 4% retirement withdrawal method.
$1,500 * 12 Months = $18,000/.04 = $450,000This math shows that generating an extra $1,500 a month is like having another $450,000 in savings! This is the magic I was referring to earlier. Read my related post How Many Income Streams Should I Have?