At the five-year anniversary of the Bernie Madoff tragedy, major news publications have published interviews with victims regarding how their lives have been altered, in some cases, by losing everything. It brings us to the question of how much money is enough.
People were attracted to Madoff because of a lack of understanding about what they were trying to accomplish. They talked themselves into taking risks to achieve what they thought was important.
Our primary objective in retirement is to be happy -- to feel good about ourselves from day to day. According to a book "The Happiness Advantage" by Shawn Achor, money beyond a certain point is not the primary ingredient in that equation. In one study, for instance, being happily married is comparable to $100,000 in annual income. What the Madoff experience seems to be teaching its victims is that they are reinventing themselves as people who don't need as much money as they once thought. A comfortable and fulfilling retirement lifestyle has turned out to be more affordable than they once would have thought.
Not that anybody enjoys being ripped off, obviously, but for what it may be worth, some of Madoff's victims are surprised at their resilience and are finding other ways to gain a sense of fulfillment. At the same time, they are far short of spending the income they once had when their assets with Madoff supposedly earned at a steady rate of 12 percent per year.
What does life look like with a more typically sized nest egg? Let's see what an accumulation of $500,000 by retirement can accomplish.
Bear in mind, $500,000 is the result of saving $250 per month and earning 10 percent per year for 30 years. For someone who started later, the $500,000 is the product of about $650 per month for just 20 years invested in something as simple as a 500 index fund. Some of that $500,000 might also be the result of capturing home equity from downsizing or selling a house and then renting. It's a reasonable minimal amount of money for anyone who has planned and saved to at least some extent. It might also be what someone winds up with even after a reversal of fortune like one of the Madoff victims.
Once in retirement, basic income comes from a combination of Social Security plus income from the $500,000. If the principle is invested in a 50/50 combination of bonds and dividend-paying stocks, it's reasonable to extract an income of about 5 percent per year and still have that nest egg, overall, rising to keep pace with inflation. What this formula ensures is that the retiree will not run out of money. The $500,000 should actually grow with inflation -- barring some doomsday event. Preserving the principle and keeping pace with inflation is critical because inflation at 3 percent will reduce the value of $1,000 down to $400 in just 20 years -- the equivalent of losing more than half the money.
With Social Security generating, say, $25,000 per year plus $25,000 in earnings at 5 percent from our retirement fund described above, the income of $50,000 is equivalent to what would have been about $53,500 per year from a job. That last $3,500 of income from a job, remember, is the cost of Social Security and Medicare taxes. In retirement, we don't have to pay those expenses anymore. We get to keep it all, and even 15 percent of Social Security is tax-free.
For the arithmetic cited above to be a reality, careful attention needs to be paid to the costs of managing the investments. All too often, the costs of advisers and financial institutions can exceed 11/2 percentage points per year. A do-it-yourself approach, whenever possible, can reduce costs to as low as 0.2 percent per year (with funds offered by Vanguard, Fidelity Spartan funds or TIAA-CREF.) The reason that most advisers and financial institutions suggest just 4 instead of 5 percent as a safe maximum withdrawal rate is that 1 percent or more of the annual earnings are being paid to them -- and there goes 20 percent of what could have been your annual income.
Keep life simple. Don't expect too much. The Madoffs of this world prey on those who are obsessed with generating some unrealistic amount of retirement income. Many retirees would be better off buying books on how to be happy rather than on how to get rich.
Stephen Butler is CEO of Pension Dynamics. Contact him at firstname.lastname@example.org or 925-956-0505, ext. 228.