Retirement Planning Solution

Written by Mitch Reiner and Wes Moss Thursday, May 05 2011

Americans are always thinking about money – how much we make, how much we spend, how much we are saving, and how much we have invested in the market. We’re obsessed with other people’s money, too – from ballplayer salaries to how much a celebrity paid for a house or an engagement ring.

This reality is never more evident than in our conversations with clients, perspective clients, and listeners to our Money Matters radio show. The same questions come up in every meeting:

• How rich am I compared to other people you see?

• How does my situation compare to your other clients?

• I need $1 million to retire, right?

While it’s human nature to measure ourselves and our accomplishments against others, comparing our wealth to that of our friends and neighbors on a dollar-for-dollar basis is a wasteful exercise. Why – because someone with $5 million can be less rich than a person with $500,000. Really! Rich is a relative term that means something different to every family. The dictionary definition of rich is, “Possessing great material wealth.” But great for one may not be great for someone else.

A better way to assess “richness” is to apply a simply equation called the rich ratio: What assets we have/what assets we need.

The goal is to have a ratio above 1 – the higher above, the better.

So, if a financial adviser tells us, based on our projected spending in retirement, that we need $2 million to retire (need) and we have only $1.5 million saved (have), the rich ratio would find us less rich than if our financial adviser tells us we need $500,000 to retire and that we have $750,000 in savings. Although, in the second scenario, we have fewer dollars, we have more than we need. This is the rich ratio.

How wealthy we are is relative to what we really need. The obvious next question is how do we figure out what we need. This is a simple exercise.

First, we must do the hard but rewarding work of developing a retirement budget. How much will we need in retirement to live the way we would like? Is it $5,000 per month, $6,000, or $10,000? Figure all of our expenses into monthly numbers. For example, if we have a $1,200 auto insurance bill that we pay once a year, add $100 to the monthly expenses.

Next, reduce these monthly expenses by any fixed sources of income. This includes pensions and Social Security payments. The resulting figure will be the “gap” -- the amount of money we will need to withdraw from investments to supplement the fixed sources and meet monthly obligations.

Once we have this monthly figure, we multiply it by 12 to get an annual number and then divide it by .04 -- that’s 4%. (Based on research, 4% appears to be a withdrawal rate that can withstand 25 years of withdrawals, even in the worst inflationary periods.)

For example, if we determine that our needs are $4,000 per month and we have $2,500 in monthly Social Security and pension income, then the gap will be $1,500 per month. This is $18,000 per year. Dividing $18,000 by 4% results in $450,000. This is the amount of assets that we must accumulate to supplement our income in retirement.

There are two ways to boost the rich ratio – save more and/or reduce projected retirement expenses. We can consider paying off the mortgage and/or downsizing. We can pay off cars and decide whether we will need more than one vehicle in retirement. We can reevaluate life insurance needs. However we do it, when we achieve a ratio of 1 plus, we can consider ourselves rich – not by our neighbor’s standards, but by our family’s standards. That’s what matters most.

Mitch Reiner is COO and CIO for Capital Investment Advisors. As COO, he is responsible for day-to-day operations. As CIO, he reviews the firm’s recommended investments and coordinates the investment committee. He monitors income strategies including closed-end funds and exchange traded funds.



Wes Moss is executive vice president and chief investment strategist of Capital Investment Advisors. He works directly with clients, providing investment strategy and guidance. He is the host of Money Matters, a radio show, and he contributes a weekly column to the Atlanta Journal Constitution, as well as being a personal finance columnist for the New York Daily News Money section.