Charleston Mercury: Six Keys to Financial Independence

From the Charleston Mercury July 26, 2012

Ever worry about running out of money during your lifetime? Many people do these days. The primary concerns seem to be the likelihood of living longer, reduced investment returns and future inflation.  Here are six rules of thumb, which followed, can help immensely:

1) If you are retired, limit annual withdrawals from your investment pot to 4%. This assumes an annual investment return of 5.5%, inflation of 3%, and the individual(s) withdrawing money for up to 30 years or more. A 65 year old couple, newly retired, with an investment portfolio of $1 million should be able to safely withdraw $40,000 in year one and 3% more each year thereafter. Note: a withdrawal rate of 6% will dissipate this investment pot in roughly twenty years.

2) If you are still working, target an investment pot equal to 25 times your expected annual withdrawals during retirement. A couple expecting to need $60,000 of annual withdrawals from their investments upon retiring at age 65, for example, will need to save and accumulate $1.5 million. Please note that annual withdrawals are calculated by adding all expenses, including taxes and then subtracting income such as social security, pensions, part-time employment, etc. Inflation must be included in the calculation.

3) Your annual investment returns need to exceed inflation by at least 2-3% per year. If not, your investment pot will vanish quickly. Currently, inflation has been running at roughly 2.5%. If inflation increases, then investment returns need to as well.

4) Focus on your housing decisions. The total cost of housing includes taxes, mortgages, maintenance, insurance and opportunity costs for the non-invested equity in the house. These costs can be 8-10% of the value of the house per year. In addition, your house may have substantial equity which may need to be “unlocked” in the future.

5) Control your expenses. Expenses are the most controllable factor in determining whether or not you will accumulate a sufficient nest egg and/or run out money. We all have the opportunity and responsibility to determine how we spend, save and invest our money. These decisions result in spending levels which directly impact the amount of our nest eggs and whether we outlive our money.

6) Don’t forget insurance and risk management. Negative financial surprises can destroy an otherwise solid financial plan for the future.

So, now it’s time for self-evaluation. If you’re in retirement, is your withdrawal rate sustainable? If you’re working, are you on track to meet your investment nest egg goals? What’s the return on your investments over the last 1, 3 and 5 year periods? Are you beating inflation? Can you afford your house? Will you need to tap into its equity at some point? Are your expenses under control? Do you monitor and review your expenses regularly? When was the last time you had an independent review of your insurance and risk management? Do you have the right coverages and are you paying the right amounts?

Finally, if your self-evaluation has added more worry than peace of mind concerning your financial future, do find the best financial counsel available.

Lester Detterbeck is one of a small number of investment professionals in the country who has attained CPA, CFP® and CFA designations.  His firm, DWM Financial Group, Inc., a fee-only Registered Investment Adviser, has offices in Charleston/Mt.Pleasant and Chicago.  Les may be contacted at 843-577-2463 or les@dwmgmt.com.