Welcome back to the 4% Rule series! In the previous posts, I introduced the topic of the 4% Rule and talked about developing a retirement budget. Both of those posts lead into today’s discussion on investment portfolio vs retirement portfolio. If you haven’t read them yet, please start there and then come back here.
In my first post, I said
But I am interested in looking at whether there is more to the story. Whether it is really as simple as “I need 25 times my expenses in an investment portfolio.” I think people tend to stop there without thinking through the entire retirement picture. In fact, I know they do, because I see comments that indicate that in online forums all.the.time.”
And in the second post, I talked about how you needed a retirement portfolio that could allow you to meet your retirement income needs using a Safe Withdrawal Rate. But did you notice (and get annoyed by) my extensive use of asterisks (*) to refer you to my end note?
*Except it’s not necessarily really the amount of money you need in your retirement portfolio. We’ll get to that next time.’
That’s what we are going to talk about today.
The bad news is it’s not as easy as just multiplying your expenses by 25 to figure out how big your investment portfolio should be. The good news is, you might find out you need significantly less than that. Retirement may be easier to achieve than you think!
Investment Portfolio vs Retirement Portfolio
Before we get into figuring out how large your investment portfolio needs to be, I want to clarify some terms I’m going to be using here. I know some of you may disagree with them. That’s fine. I’m going to be using them a bit differently than you might have seen in the past. But it’s okay…we’ll get through it.
Investment Portfolio
Investment portfolios are exactly what you probably already think they are – things you have bought (invested in). That might be cash, or stocks, or bonds, or REITs, as well as a lot of other things. You can derive a retirement income from your investment portfolio either by receiving payments from these things (dividends and interest) or by selling them. It’s pretty straight forward.
My investment portfolio is comprised of my TSP, my IRA, and my taxable investment accounts.
Retirement Portfolio
When I say retirement portfolio, what I’m referring to is all of the sources of income you will have in retirement whether you control them or not. For instance, I consider my retirement platform to be my retirement portfolio, minus the medical care since I don’t receive money from that. It’s a lot more than just my investment accounts. It’s the possibility of a pension, the possibility of earned income, and Social Security, too. My retirement portfolio includes my investment portfolio, but they aren’t one and the same.
Now if you Google retirement portfolio, that’s not how other people describe it. You are going to see a lot of descriptions that sound exactly like what I called an investment portfolio, except specifically for the purpose of retirement.
The reason I do it this way is because I need a way to explain to people that retirement income is more than 401ks and IRAs. So you have an investment portfolio (hopefully), but then you have more things that also make up your retirement portfolio.
Real estate that you rent out for a profit could arguably be included in the investment portfolio or not. I leave it out (but include it in my retirement portfolio) because it is not a liquid investment – I can’t sell parts of it easily. That means I have to treat it differently than I would my investments – I can’t just decide I’m going to double how much I pull from it in a given year, for instance. And I can’t decide not to take any income from it unless I leave it empty…not a good plan. But if you want to include it in your investment portfolio, I won’t question it.
The 4% Rule Applies After Accounting For Other Retirement Income
The reason I point this out is that the 4% Rule (or any other safe withdrawal rate) is specific to how you will pull money out of investment portfolios. It is only needed after you have already accounted for income coming from non-investment portfolio sources.
Here’s what I mean.
Say your retirement budget (including taxes) requires $60,000 in retirement income. The 4% Rule would suggest you need $1,500,000 in your investment portfolio in order to safely pull $60,000 out during the first year of retirement. That’s $60,000 times 25 = $1,500,000. You’d then adjust your withdrawals slightly each year to account for inflation and market fluctuations.
Other Income Sources
But most people aren’t going to rely entirely on an investment portfolio. They will have other sources of income in retirement that will offset the need for income from the investment portfolio. Those sources, which are all potentially part of a retirement portfolio, include things like:
- Pensions and Annuities
- Social Security
- Rental Property Income
- Residual Income
- A part time job
- An inheritance
You might be looking at this list with a skeptical eye. Some people are going to think “uh, not all of us are getting pensions, Mil$.” Others are going to think “Social Security won’t exist once I’m retirement age!” Personally, I look at inheritances and think “You’d better not be planning on that.”
But the point is, you will probably have at least one source of retirement income that isn’t in your investment portfolio. Personally, though I am not accounting for it in my retirement planning, I expect to receive some sort of Social Security check when I reach that time in my life. It may not be the full amount they are currently predicting, but I don’t think it will be zero.
Social Security is simply too important to too many taxpayers (voters) for it to go away completely. Instead, what I expect to happen is some combination of raising the age at which you can receive benefits, plus increasing revenue, plus some reduction in the expected benefit. Either way, I’m not counting on it but I do think I’ll get something, so that’s the cherry on my retirement sundae. If nothing else, it can act as a form of inflation protection.
Subtracting Known Retirement Income From Your Withdrawal Needs
Getting back to the $60,000 example, let’s look at how to use your retirement portfolio as a whole to determine the size of your needed investment portfolio.
You start by subtracting all of the money you’d receive from the other income sources in the retirement portfolio in order to determine what your investment portfolio needs to look like.
This can lower the amount you need invested quite a bit and still allow you to utilize a safe withdrawal rate to meet your retirement needs. Remember that the inverse of the 4% Rule is that you need 25 times any given number in order to spend that money in retirement. So if you want to take a $3000 trip every year in retirement, you need $75,000 in your investment portfolio to pay for it from investments ($3000 times 25 = $75,000). But if instead you have a $3000 per year pension then you don’t need that money in your investment portfolio.
Another way to look at that is that for every $100 you have in retirement income from non-investment portfolio sources, you can subtract $2500 from your “expenses times 25” equation.
In the next 4% Rule post, we’ll go through some examples of this. I’ll show you a fictional example (but based on real people) where their investment portfolio is very small, but they have a large enough retirement portfolio to meet their needs. And I’ll run a military-specific example for those readers. I’ll also talk a bit more about how to nail down your retirement budget, especially when you are looking decades into the future.
Until next time…
i’ve been looking a lot at dividend income as we get closer to not needing to work. i like the liquidity AND income these stocks provide. for 7 bucks and a few keys strokes your shares are turned into cash that you can have in your bank account in a few days. i have been looking lately at successful companies with a good competitive moat generating boatloads of cash flow who will be the future dividend aristocrats. i’ve also been looking at “effective dividend yield.” For instance, if you bought disney shares in 2007 the share price was 34 bucks a share and they were paying out 31c a share annually in dividends for a yield of less than 1% which is pretty piss poor. however, the current annual payout 10 years later is $1.68 a share and the yield on a $110 stock is about 1.5%. but consider that $1.68 against the 34 bucks you paid if you bought and held it 10 years and the effective yield now from where you bought it is 4.9% and most people would take that as an income stream plus all the reinvested dividends you got along the way.
that’s 2 cents worth of something. also hoping for a pension buyout from big brother as i trust me to handle the funds more than them.
A pension buyout isn’t an option for me but I feel ya on the Disney dividends! I’ve purchased it 3 times, plus I DRIP it so I have partial shares from that. My lowest total share cost basis was 5 shares purchased at $36.99 each. My highest was 6 shares at $68.45 each. But if you count DRIPs, I bought 0.016 shares at $21.88/share! If only I’d bought more!