<FOOLISH WORKSHOP>
Retiring With BSP
by Ethan Haskel ([email protected])
Baltimore, MD (May 5, 1999) -- If you ask one hundred Workshop Fools why they want to maximize their investment results, you'd probably get one hundred answers. I'd hazard a guess, however, that the word "retirement" would come up a lot more often than the word "rich."
How do we know when we have enough money to retire? This question recently was transformed from an academic exercise to the ultimate reality check when I was asked by my mother to chart her investing course as she contemplated giving up the nine-to-five life.
Peter Lynch, the legendary fund manager, penned some of the most succinct and Foolish words on the matter in two pieces for Worth Magazine published in 1995 and 1996. The first, titled "Fear of Crashing," is an excellent treatise on why you shouldn't try to time the market. He then goes on to develop his theory as to why even retirees should be fully invested in dividend-paying stocks rather than bonds or cash. Mr. Fidelity refines his theory in his subsequent article, "The 5 Percent Solution."
Mr. Lynch notes that even a 65-year-old male retiree is expected to live for another 20 years and thus should consider that his investments are about as long-term as someone much younger. And most Fools realize that for long-term investors, stocks, not bonds or cash, are the place to be.
If you can live on an annual income that's equal to five percent of your total investment stash, you're set. (Remember that this income must include all that's needed to live, including taxes, insurance, and other monthly living expenses.) How does this work?
Let's say for the sake of round numbers that you've determined that you need $50,000 in annual income to live a satisfactory lifestyle in those golden years. You can simply multiply by twenty to find the amount of investments you'd need to do the job. (The twenty factor is just a mathematical sleight-of-hand that lets you come up with the five percent number in an easier way.) Fifty-thousand dollars times 20 is $1,000,000.
One option is to invest in a ten-year treasury bill that might pay something like 5% per year, giving you the needed $50,000 annual salary. At the end of 10 years, you'd have collected a total of $500,000 for your living expenses and still have your original $1,000,000 to continue the scenario ad infinitum. Not bad.
But wait. That old devil inflation is about to rear its ugly head. By the end of the decade, your $50,000 wouldn't buy nearly as much as it used to. Assuming an inflation rate of 4%, that $50,000 in the year 2009 would buy only about $31,000 worth of goods in 1999 dollars. That probably means a whole lot more peanut butter and jelly sandwiches for dinner than we had planned!
Peter Lynch has a better way. Taking out your required $50,000 living expenses to start the first year, you're left with $950,000 of your original million-dollar stash. Let's invest that in stocks and see what happens. For the sake of argument, we'll assume each and every year you'll receive the stock market's historical average return of 11% each year. (We know this will never happen this way, but we'll use this example as a starting point for our discussions.)
After the first year, your investment portfolio would be worth about $1,055,000, or $55,000 more than you started with, even though you spent $50,000 to live on. The second year, you'll need $54,000 to live, giving yourself that 4% raise to keep up with inflation. You'd sell $54,000 in stocks to pay the upcoming bills for the year. Again, assuming an 11% investment return, by the end of the second year you'll have about $1,113,000.
Let's fast forward ten years. We've implemented our plan faithfully, each year withdrawing our inflation-adjusted allowance while allowing our money to grow in the equities markets. By the end of the decade, we've got a tidy little stash of $1,762,000 -- $762,000 more than if we had bought that treasury bill. The compounding clown strikes again! Not only that, you've paid yourself out a total of about $600,000 -- $100,000 more than if you went the T-bill route.
As Foolish Workshop investors, however, we're rarely satisfied with achieving market-equaling returns. As a retirement strategy for equity investing, I think either the Dow Dividend strategies or Beating the S&P (BSP), or a combination of both, is highly appropriate. With either of these strategies, you're investing in the largest blue chip companies, whose performance actually tends to shine best when markets are looking dicey -- a time when retirees might be most concerned.
Let's run the numbers for the above strategy with the actual BSP returns, as if a hypothetical retiree had retired in 1987 (the year of the dreaded "market crash," by the way).
Year BSP Return Portfolio at start Amount Removed Portfolio at end
1987 13.1% $1,000,000 $50,000 $1,075,000
1988 32.1% 1,075,000 52,000 1,351,000
1989 25.8% 1,351,000 54,100 1,631,000
1990 -4.3% 1,631,000 56,200 1,507,000
1991 25.5% 1,507,000 58,500 1,818,000
1992 3.9% 1,818,000 60,800 1,826,000
1993 20.2% 1,826,000 63,300 2,119,000
1994 5.6% 2,119,000 65,800 2,168,000
1995 40.0% 2,168,000 68,400 2,939,000
1996 33.3% 2,939,000 71,200 3,828,000
1997 33.0% 3,828,000 74,000 4,993,000
1998 28.9% 4,993,000 77,000 6,337,000
Holy golden cow, Batman! After a dozen years, our BSP rainy day fund is starting to have a rather nice glow to it, don't you know? If we decided to apply the 5% rule of thumb to our now 6-million-dollar-plus portfolio, we'd be able to pay ourselves an annual salary of over $300,000 dollars. Life just took a slight turn for the better!
Now, of course I've oversimplified things quite a bit here to make a point. But for broad-stroke retirement planning, this is as good a start as any. I've also given you one heck of an optimistic investment scenario. We cannot and should not expect 20-plus percent annual growth for an unlimited time frame (although that's not far off from the long-term results of some of the Dow Dividend strategies). In future columns, we'll analyze this 5% plan using other scenarios, including a few when the market behaved like a very bad boy.
For another spin on the five percent solution, check out two Robert Sheard classics, "The Twenty Factor," and "More on the Twenty Factor."
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Beating the S&P year-to-date returns (as of 05-04-99):
Schlumberger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLB)") else Response.Write("(NYSE: SLB)") end if %> +39.2%
Kimberly-Clark <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %> +10.1%
Campbell Soup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPB)") else Response.Write("(NYSE: CPB)") end if %> -25.9%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> +10.8%
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> +17.9%
Beating the S&P +10.4%
S&P 500 +8.7%
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +21.0%
S&P 500 +18.1%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $105,300
S&P 500 $77,400