Last week, I realised that I’d never gotten round to a blog post on the retirement savings question. And then this morning, I saw this reader question on Moneyweb:
Some general notes:
- An investment vehicle paying out R15,000 per month, into perpetuity, off a R500,000 initial investment, would have to generate after-tax returns of 36% per year in perpetuity.
- And even if you did find that type of investment, inflationary increases in the cost of living would make that payout too low within two to three years.
- But also, retirement at 46? Really? If you live until your 90s, that means you’re expecting to live off the savings of your working life for twice as long as your actual working life…
I don’t mean to sound harsh, but we must be serious. It seems to me that the big downside of longer life expectancy is a longer working-life requirement.
But let me just put that to the side briefly, and address the math part.
Retirement Savings: The Math
I’m going to work off this semi-worst case scenario:
- After you retire ‘early’, let’s say you live for another 50 years.
- You’d need at least R30,000 (after tax) per month, to cover some really high medical aid premiums. On that, you could live relatively comfortably.
- You’re able to earn an after-tax real return* (ie. after inflation) of 1% per annum (that seems to be the fun future that we have to look forward to).
*I’m using a real return, because it implies that the ‘extra’ return on your investment will compensate you for inflation, so you’ll always be able to draw the ‘real’ equivalent of whatever R30,000 could buy you today.
Here is how much you need to have saved up before you can retire:
Speaking to that reader question, assuming that R15,000 (after tax) per month is going to cover all the necessaries (in real terms) for the same time period, then total savings need to be:
Now that’s a semi-worst case scenario (in either situation), because we’re happily taking for granted:
- that you’re going to consistently earn a positive real return;
- that you’re not going to have any dramatic cost-of-living changes;
- that you’re not especially exposed to exchange rate fluctuations;
- that no financial crises drive your asset manager, or any of the funds that they’ve invested in, into bankruptcy; and
- that your country does not undergo a period of political instability.
That last one is a risk that most people seriously underestimate (in my opinion). Long-term political stability is the exception, not the norm. And because we’ve just lived through a fairly exceptional period in the world’s history, it’s quite possible that we’re falling victim to a bit of cognitive bias.
But don’t despair.
The secret: don’t retire
I personally have no plans of retiring, for as long as I can avoid it. I’m not saying that’s for everyone, but let me start by asking a slightly-tangential question: who can retire early?
That is: who has enough money, today, that they need never work again?
Answer: the really rich.
Here’s a follow-on question then: why don’t they just retire?
Because, I mean, they don’t retire.
The people who have enough to retire, choose not to. The rest of us, who don’t have enough, are frantically trying to accumulate it.
Given that, here’s my real question: what if we also reach that point, only to discover that ‘doing nothing’ for the rest of our non-working lives seems like a really terrible idea?
Clearly, there is something about being productive and useful that makes rich people work, even if they have no material need to. And if that’s the case, and you can find joy in being useful and productive, then the drive to retire early can…recede. We may eventually want to slow down, and work less (ie. take more holidays) – but to stop working altogether should not be such an urgent goal.
And I reckon that our focus should shift away from “saving enough for retirement” to “ensuring that we always have some form of work to fall back on”. Whether it’s through being entrepreneurial, or upskilling ourselves to remain relevant in the work force, we should also be trying to make sure that ‘earning an income’ is a possibility for many years after we’ve passed the age of retirement.
And my real fear is that’s something we’re not really thinking about.
PS: I know that I could have used the “4% rule” to do some of those retirement savings calculations. My main concern with that: it assumes that historical returns are a good indicator of future returns. Me, I am less sure of that. I think that we should bank on a much-lower-return world, going forward. But perhaps that deserves its own post.
Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, or like the Rolling Alpha page on Facebook at www.facebook.com/rollingalpha.
Marc March 14, 2017 at 07:15
Hi Jayson – this blog is one of the best things I’ve found in years! Love the material, particularly because you actually seem to know what you’re talking about, unlike the vast majority of people writing about economics and finance.
Quick question – your calculation regarding the R14 mil producing R30 000 after tax, at a 1% return after inflation. Could you go into a bit more detail about this? I seem to get about a 3% withdrawal when I do the sums, which doesn’t seem to tally up with what you’ve said.Reply
Jayson March 14, 2017 at 08:35
Hey Marc – thanks for the compliment!
So to answer your math question, that’s just an excel formula. You know how the formula to calculate Present Value goes PV = (interest rate per period;number of payment periods;monthly payments;other optional stuff)? So here was my formula:
PV = (1%/12;50*12;-R30,000) = about R14 million
And then if you work that back to a drawdown, then you do get to a bit less than your 3% figure, but that’s in the range. So I think we’re talking about the same thing?Reply
Marc March 14, 2017 at 11:30
I believe we are – I worked out, very approximately, how much your monthly amount would be before tax (R35K to R37K), and what kind of percentage drawdown that would be off R14 million.
All the finance bloggers – tongue firmly in cheek – have taught me that once you have enough money to fund a drawdown of 3% to 4% per year, then you don’t need to worry about how long your retirement period will be. Using that PV formula, though, gives remarkably different results if you plug in 20 years vs 50 years. I’m trying to understand how the two methodologies mesh.Reply
Jayson March 14, 2017 at 13:28
So. That idea comes from historical returns. That is: financial planners work back historically to look at what your maximum drawdown could have been over the last 10/20/30/40 years to determine what level of drawdown would not have been a big problem for your capital base, given the returns over that period (which included some booms and some crashes).
My concern is that, overall, we’ve actually had fairly high returns in the recent era: lots of economic growth, due to productivity gains from globalization and technology. But global economic growth seems to be slowing (some might say ‘normalising’) – and that means lower returns in the future. Which might make that 4% rule less of a rule.
I’ll have to write a post on the 4% rule 🙂 Because maybe I just haven’t looked at the math behind it properly!Reply
Marc March 14, 2017 at 14:36
I’m not sure if it’s maths, so much as extrapolated market returns based on the past and many, many assumptions 😛
The guys that preach this early retirement gospel all seem convinced by the 4% rule. The average market return in the States is historically 7%, inflation is 3%, so extracting a maximum of 4% allows your principal to grow enough to cover inflation, whilst covering you from pretty much anything the economy can throw at you. I take this to mean that, in South Africa, your principal would need to be growing by 10% annually for your capital to not be eroded by inflation or your withdrawals. Personally, man, I can’t help but be very pessimistic about that figure, especially when I look at what my RA’s have been doing for the last few years. Maybe I’m misunderstanding what they’re all saying, and things aren’t as dire as what they seem – I hope so!Reply