I want you to radically rethink your retirement fund. Don't limit yourself to a 401(k) plan and a Traditional IRA or Roth IRA. Don't just think about investing in stocks or investing in bonds. Instead, start thinking of ways you can expand your income pie including getting paid for doing what you love on a part-time basis. That is, think in terms of how you can augment the money earned by your retirement fund with income that flows from your passions and hobbies rather than work. The effect on the amount of money you need to have saved in your retirement fund can be enormous.
Imagine that you are the typical American household, earning $50,000 +/- per year. When you retire, you'd need around $1,250,000 in retirement funds to produce the same pre-tax income if you followed the famous 4% rule and never touched any of your principal so you could leave an inheritance to your family or to your favorite charities.
The Effect of Pensions, Social Security, and Other Sources of Income on Your Retirement Funds
But you are likely to draw some income in retirement. The average monthly Social Security benefit at the beginning of 2011 was roughly $1,177, or $14,124 per year. Backing that off the average income of $50,000, you would only need $35,876 on top of your Social Security checks to maintain your standard of living. Using our same 4% rule, that would require $896,900 in retirement funds, or $353,100 less than you had originally needed.
But what if you have a passion for being around people? In my grandmother's generation, some of her friends took jobs working in what would be considered low-wage retail not for the money but to get out in the community and have a sense of purpose. Some worked as baristas at coffee houses, some as door greeters at retail stores, while still others became part-time receptionists for non-profits. With earnings of $10,000 per year, it's certainly not "career" money but it does bring household income up to $24,124 when combined with Social Security.
That leaves you only $25,876 short before reaching the same $50,000 you had prior to retirement. That money is going to have to come from your retirement funds in the form of dividends, interest, rents, etc. If you insisted on adhering to the 4% rule for the sake of fiscal conservatism, you would need to have only $646,900 in savings. That is $603,100 less than we thought you'd need when you started out at the beginning of this calculation.
Unconventional Thinking Might Help You Wring More Cash Out of Your Retirement Funds
Here is the kicker: The 4% rule was created as a result of stock market volatility and inflation. From time to time, stocks fall 50% or more. If you kept a high withdrawal rate, even in the face of 10% to 11% long-term stock market returns (6% to 7% after inflation), by hitting a bad year, you could lose your entire portfolio. The 4% rule protected against those fluctuations by keeping enough principal working to survive even a Great Depression scenario. This begs the question: What if you could own an asset class that didn't experience fluctuations on the scale of the stock market and had a built-in hedge to protect against a rise in the inflation rate?
I know an older investor who answered this question for his family. He owns a portfolio of real estate that is purchased on a value investing basis. He waits for foreclosures in good neighborhoods, buys the properties, renovates them, and then rents them at a rate that generates 10% returns after adjusting for maintenance, depreciation, property taxes, vacancies, and other expenses. He only buys a property every few years when the price is right and he studies his markets extensively. He has considerable experience and is obsessed with reducing risk. The past three or four years have been great for him due to the real estate bust, primarily because he never uses debt to buy the rental houses or office buildings, instead paying cash from his savings. With no leverage, opportunities have abounded since 2008 for his portfolio. That takes care of the volatility; and as for the inflation rate, rents can be raised regularly in a healthy community.
If you had the same knowledge base, it would only take $258,760 in property to generate the $25,876 remaining to get your household income during retirement to the $50,000 you require to maintain your standard of living. That is $991,240 less than you thought you'd need in the beginning. That would have only required you to save $48.72 per month at 10% for the 40 years you had your regular career; a feat that should have been easily doable barring a catastrophic disaster.
