The Daily Dow
Tuesday, October 21, 1997
by Robert Sheard
LEXINGTON, KY. (Oct. 21, 1997) -- I want to follow up on Thursday's column ("The Twenty Factor") since it has generated such a positive response. There were many questions about how this approach takes inflation into account and whether there's an easy way to administer the approach.
Just to recap what the Twenty Factor is: in trying to calculate how large your portfolio must be in order to sustain you in retirement forever, I suggested you start by determining how much you would need as a retirement salary today to live comfortably (include all your expenses in this figure, travel, fun, and taxes, as well as more mundane daily costs of living). Then simply multiply that figure by twenty. That's how much you would need in your portfolio today to retire. (If you're still approaching retirement, of course, you would revise this figure each year if necessary, using whatever "salary" you require at that time.)
For example, if you could retire comfortably on $60,000 a year right now, you should have a portfolio of $1.2 million. Now how does this work from year to year?
At the beginning of the year, take out 5% of your portfolio assets and put them in some kind of a guaranteed and liquid account (a money market checking account perhaps) so you can draw on the balance throughout the year. In our example, that would be the $60,000 you determined should be your retirement salary today.
The remaining 95% ($1,140,000) would stay invested in your portfolio. Let's say it earns the long-term S&P 500 Index average of roughly 11%. (We hope you'll do much better, of course, but let's be conservative.) Your portfolio would grow to $1,265,400, even after having withdrawn your full year's salary to start the year.
At the beginning of year two, then, you repeat the process, withdrawing 5% of the total ($63,270) and investing the rest. You've given yourself a 5.45% raise in your annual salary, which should adequately keep up with inflation -- and your overall portfolio is still growing. Of course, if your investments average better than 11% (and they should), your annual raises would be even larger, keeping you far ahead of inflation, which is the retiree's worst enemy.
And since you're never taking more than 5% of your portfolio in any one year, you're protected by a pretty fair cushion against bear markets, even ones as nasty as we saw in 1973 and 1974. Your annual salary might slide a little in those years (or the percentage you pull out might rise temporarily if you absolutely can't take a salary reduction), but you have enough room to accommodate that in the Twenty Factor plan.
So don't think about retirement in terms of age; think of it in terms of a percentage of your portfolio. When your salary needs are only 5% of your overall portfolio, you can retire comfortably and sustain your lifestyle indefinitely. Fool on!
P.S. With today's continued strong move in AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %>, the Foolish Four passed the return for the overall Dow Jones Industrial Average for the first time, I believe, all year.
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. ________________________________
Stock Change Last -------------------- T +2 1/4 49.75 GM +1 7/16 71.31 CHV + 15/16 87.81 MMM +1 94.81
Day Month Year
Day Month Year
FOOL-4 +2.62% 7.73% 25.15%
DJIA +1.75% 1.45% 25.00%
S&P 500 +1.74% 2.64% 31.26%
NASDAQ +1.61% 1.59% 32.65%
Rec'd # Security In At Now Change
1/2/97 153 Chevron 65.00 87.81 35.10%
1/2/97 179 Gen. Motor 55.75 71.31 27.91%
1/2/97 479 AT&T 41.75 49.75 19.16%
1/2/97 120 3M 83.00 94.81 14.23%
Rec'd # Security In At Value Change
1/2/97 479 AT&T 19998.25 23830.25 $3832.00
1/2/97 153 Chevron 9945.00 13435.31 $3490.31
1/2/97 179 Gen. Motor 9979.25 12764.94 $2785.69
1/2/97 120 3M 9960.00 11377.50 $1417.50
CASH $1167.51
TOTAL $62575.51