The question for working Millennials is no longer how to become a millionaire. It’s why you’ll need at least $1 million to retire comfortably. And if you plan to retire by the age of 65, $1 million dollars might not even be enough.
The focus of this blog post is on Millennials, which account for 25% of the total US population. Our subjects are a newly married 30-year old couple with the following profile:
- Beginning portfolio: $20,000
- Annual savings rate: $5,000
- Desired retirement spend: $100,000
- Social Security: $40,000
- Portfolio real returns (pre-retirement, after inflation): 6%
- Portfolio real returns (during retirement, after inflation): 4%
- Blended tax rate: 15%
The first question:
How long does it take our couple to accumulate $1 million?
Given the above assumptions, it would take our 30-year old savers until they reach 68 to get to a $1 million nest egg in today’s dollars. Granted, any of these assumptions could easily change. For instance, doubling our savings rate to $10,000 a year, our couple would reach $1 million at the age of 59 years. So our first takeaway: save.
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The second question:
How far does that $1 million reach?
The $1 million does not quite get our subjects to their desired $100,000 per year spend. In fact, our 30-year-olds would run out of money by the time they reach 84 (before their life expectancy of 86 and 89, respectively, for him and her). That’s because during retirement, their 6% return is likely to dwindle to 4% as their risk profiles– and investment strategies – shift to become more conservative. Retiring at a “normal” age of 65, they would have been out of money by the time they were 80.
The earlier you retire, the less runway $1 million will give you.
The below chart illustrates this concept further. Using the retirement assumptions outlined above, we show the maximum amount the couple could spend each year during retirement if they retire with $1 million in five-year age-increments. All else equal, as the chart illustrates, the couple needs to delay retirement to achieve their desired goals.
The third question:
How much would the couple need to retire given their goals?
As shown in the chart below, this figure is highly dependent on age and life expectancy. The figure shows the bare minimum that you’d need for retirement with a life expectancy of 89 years given our all of our assumptions.
Simply put, retiring earlier means you need to have a bigger nest egg.
People appear to believe they can handle working later into their lives, especially as life expectancy is becoming longer for those maintaining healthy lifestyles. But to retire comfortably with only a million, you need to be 75. That’s 10 years after the normative American retirement year. To retire at 65, Millennials will need closer to $1.6 million.
The fourth question:
How can this picture change?
First, you can move away from this notion of “depleting” your portfolio if you set a target spend level that is lower than the yield on your portfolio. Traditionally, this has been known as the 4% spending rule – a 4% withdrawal rate is typically less than the yield of a retirement portfolio. Spending less than you make is not a bad rule of thumb.
Of course, our analysis can also be changed by tweaking or adding assumptions; in the real world there are many other factors that impact retirement. Unexpected expenses, such as medical care, could make the numbers even more challenging to reach. On the other hand, ownership of real estate or other assets could brighten the picture we’ve painted.
Similarly, both of our hypothetical portfolios (pre-retirement and post-retirement) have a significant portion in equities, which have exhibited a standard deviation of 20% over time. What this has meant over history is that certain years have been better to retire than others. Returning to our saver couple, if they began their 38 years of saving in 1975 and retired in 2012, they would have nearly double the retirement savings that they would have if their timeline was shifted 4 years earlier. In other words, if the couple happened to have been born 4 years earlier, begun saving 4 years earlier and retired 4 years earlier during the market trough in 2009 they’d have half as much as they would have in our first scenario.
While there’s a long list of factors that complicate any forward-looking analyses, the bottom line is clear: to be comfortable in retirement, you may need more than we think. It’s never too early to think about retirement, and Millennials will be well-served to begin thinking about savings and investing habits that can prepare them for their long-term financial needs.
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