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SJul 20, 2006

The Best Retirement Formula: Make Your Own

Q. Please email me your formula for figuring how much money it takes to retire. I am 72 and still working. ---J.A., by email from Dallas, TX

  

A. For better or worse, I have no such formula. The best we can do is come up with different rules of thumb, all of which have the accuracy and grace of thumbs. Sadly, rules of thumb put too much emphasis on investment returns. They seldom consider what you and I, personally, can do to have a major impact on our retirement needs. Consider these truths:

  * The most important agent in your retirement is you. In fact, you have more power over your life in retirement than you had during your working years. Most people don't understand this. But if you are an employee--- which is what most of us are--- you don't have much to say about your income, benefits, or job duration. Retired, all those uncertainties disappear, and you become the direct agent making the decisions that affect your day-to-day life.

  * The fastest and most powerful way to change your retirement is to work on your expenses, not your investments. If you say you want to spend $100,000 a year in retirement but have only $50,000 of investments, you have a problem. You can't get there from here. But you can change the income you need in retirement through dozens of big and small decisions.

You can downsize your house. You can move to a less expensive area in a less expensive state. Like the couple I wrote about recently, you can become a "full-timer," traveling inexpensively around the country in an RV. You can take care of your personal health rather than abuse it. You could even join with others to share living expenses.

One of the truly great things about America is our national genius for finding ways to create and distribute goods at the lowest possible costs. For every dream of an inexpensive retirement in Mexico or Panama, the USA offers hundreds of out-of-the-way spots with very low living costs.

  * The power of your personal decisions is enormous. Every dollar of spending you avoid eliminates sales taxes and income taxes. Follow this trail. An item priced at $1.00 will cost $1.075 with a typical sales tax. To net $1.075 after a 15 percent federal income tax, you need to earn $1.26 on your investments. At a safe withdrawal rate of 4 percent, that means you need $31.61 in investments to support every $1 of retirement spending.

If you happen to trigger the taxation of Social Security benefits or live in a state with an income tax, the investment multiple you will need can be much higher. A retiree who triggers the worst possible rates will need to earn $2.00 on his investments to generate $1.075 of after-tax income to buy something that costs $1.

Every dollar he doesn't spend will eliminate the need for $50 in investments.

    * Once you've got a budget that works, knowing what you need to retire is easy. Take your annual budget, including income taxes. Subtract your Social Security benefits. Multiply the remainder by 20 or 25. If you spend $40,000 a year while working, personal decisions can take the amount needed down to $30,000. If your Social Security benefits are $1,000 a month, that means you'll need $18,000 a year from your nest egg or $360,000 to $450,000 in investments.

  

Q.   If I had about $80,000 to invest, why not buy one share of Berkshire Hathaway instead of a large-cap fund? It seems to be a well-diversified company, and I know that it's going to be run very well without ridiculous fees or wasted expenses such as trading costs.

---B.J. by email from New York

  

A. You'd be a little short of the $91,450 you'd need to buy a single share of BRK.A at a recent price, but you could always buy shares of BRK.B at a recent price of $3,043 a share. Over the last three years the stock has provided a return about equal to the S&P 500 Index. That's a disappointment to most investors, but since the company is a mixture of stocks and bonds, its performance compares well to a traditional balanced fund. Morningstar judges the stock to be significantly undervalued.

One thing certain: With no dividend, it's a very tax-efficient way to accumulate capital in a taxable account.

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Personal finance writer Scott Burns is syndicated by Universal Press. His twice weekly column appears in newspapers from Boston to Seattle. He is the Chief Investment Strategist for AssetBuilder, Inc. Readers can register at www.scottburns.com. Questions/comments can be posted directly. They can also be sent, without registration, to scott@scottburns.com. Questions of general interest will be answered in future columns and on this blog.

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Filed Under: Income Investing, Q&A (from print), Retirement