How You Determine Your Rate

Monday, March 5th, 2012

As we discussed in a previous article, investing in your retirement years without first knowing the investment rate of return that you MUST earn is the equivalent of taking a new potent drug because it’s popular and everyone’s talking about it!

When we use the medical analogy, it seems ridiculous. Yet, this is what the overwhelming majority of retirees do.

They blindly read a magazine, watch a television show, or meet with an investment salesperson and froth at the mouth over the latest new “Can’t Miss / Hot” investment.

Don’t get lazy and fall into the trap. Do whatever is necessary to discover the investment rate of return you MUST earn first.

How Do You Determine Your “Rate”?

The investment rate of return you must earn is dependent on three factors:

  1. Your Level of Retirement Bucket™ Dependence: how much money you need to withdraw from your Retirement Bucket™ each year to supplement your social security, pensions, and rental property income (if you own rental property),
  2. The Size of your Retirement Bucket™: the amount of money you’ve accumulated over your lifetime to draw from to provide this supplemental income, and
  3. Inflation

The good news for you is that I’ve outlined how you can determine your level of dependence using steps one and two of The Relaxing Retirement Formula™ over the previous month.

Have you done your homework? If not, and you want to confidently spend what you’ve taken your entire life to accumulate without fear, I can’t urge you enough to take these initial steps.

Calculating the size of our Retirement Bucket™ comes down to you having accurate and up-to-date statements on all of your bank and investment accounts. Given that we’re at the beginning of a new year, you should be able to put your hands on December 31, 2011 statements rather easily.

That brings us to #3. As we discussed last week, when it comes to inflation, you have to make some assumptions as to what you believe the rate of inflation will be in the future. Without going into too much detail on that issue here (I’ve gone into great depth about my opinion on inflation in prior blog entries and will do so in the future), I strongly recommend that you assume a higher rate of inflation than the present to be conservative.

Getting back to Steps One and Two, once you know your level of dependence, i.e. the amount of money you need to withdraw from your investments each year to keep pace with inflation, and you know the amount of money you’ve accumulated in your Retirement Bucket™, the rate of return you “need” to earn is the rate that allows your money to remain intact year after year while allowing you to continue to spend what you want.

Can you see why you must know this?

If you have a large Retirement Bucket™, and you only need to withdraw a little bit each year for your supplemental income needs (like John and Mary Independent in our case study over the last few weeks), you probably don’t need to earn a very big rate of return.

On the other hand, if you need to withdraw a lot of money each year from your Retirement Bucket™ like Ron and Rose Reactionary, you may need to earn a much bigger rate of return.

Either way, the key is knowing that rate because if you don’t, you may very well be investing more aggressively than you need to and subjecting yourself to far more volatility than you need to.

And, at the same time, if you don’t know the rate you need, you may be investing too conservatively and run out of money because your money isn’t growing fast enough to keep up with your spending needs.