Million Dollar Myth

The mil­lion dol­lar myth, that a mil­lion dol­lars in the bank is “mak­ing it”, seems deeply root­ed in our cul­ture. It seems a fin­ish line of sorts. A mea­sure of suc­cess.

It is.

With a mil­lion dol­lars in the bank, you cer­tain­ly aren’t wor­ry­ing about how to pay next mon­th’s bills. Or whether to splurge on expen­sive Starbucks lattes.

Unfortunately, as a retire­ment bench­mark a mil­lion dol­lars does­n’t get you very far.

Ask any­one who’s put any thought at all into retire­ment, and they’ll quick­ly cal­cu­late the 3–4% rule on a mil­lion bucks to real­ize that it only means $30,000-$40,000 a year towards retire­ment income. How are you going to make up the gap? The gap between $40,000 and what you’re earn­ing now? So you own your home? That’s a start. But there are just too many unknowns. Unknowns that make trans­lat­ing port­fo­lio bal­ance to retire­ment income lit­tle more than guess­work.

Without fur­ther cal­cu­la­tions or esti­mates an account bal­ance is mean­ing­less. Worse yet, the esti­mates? They’re real­ly just guess­es! What do you expect infla­tion to be 10 years after you retire? How will the mar­ket per­form over time? How long do you expect to live? Will your spouse stay healthy? Any of these answers are noth­ing more than guess­es. Educated guess­es per­haps. But, still just guess­es.

It’s dif­fi­cult for a ‘reg­u­lar per­son’ trans­late a mil­lion dol­lar account bal­ance into some­thing that clear­ly defines a retire­ment plan.

It seems that unless you have a pro­fes­sion­al finan­cial back­ground, it’s just  too com­pli­cat­ed to come up with a plan to man­age a retire­ment port­fo­lio. Brokerages and finan­cial advi­sors who make mon­ey from the con­fu­sion aren’t moti­vat­ed to change things. A change of this sort is real­ly dif­fi­cult emo­tion­al­ly too. Measuring account bal­ance is some­thing deeply root­ed in how we think about mon­ey, even though from our very first pay­check we aren’t man­ag­ing our per­son­al “bal­ance sheet” but our per­son­al “cash flow”.

The Million Dollar Mistake

The fun­da­men­tal prob­lem is that mea­sur­ing the account bal­ance is mea­sur­ing the wrong thing.

Why not think dif­fer­ent­ly from the get-go? Why not start by mea­sur­ing invest­ment “income” instead of port­fo­lio “bal­ance”? Instead of think­ing: “I have a mil­lion dol­lars in the bank”, think instead: “I have “$40,000 a year in income, and over the next year I expect a $4,000 raise.”

It’s quite hard to change this per­spec­tive com­plete­ly. I know from my own expe­ri­ence! Though I track my Elephant’s Paycheck and rais­es, I still stress when the size of my Elephant (my port­fo­lio val­ue) gets small­er. By the way, my Elephant gets about 30 rais­es a year, each com­pound­ing over time. The com­pound­ing ensures that my Elephant’s rais­es accel­er­ate over time, rather than flat­ten out like the rais­es I get at my job do. The num­ber of rais­es is sim­ply a fac­tor of how many dif­fer­ent com­pa­nies I keep in my port­fo­lio (6) and not the port­fo­lio size.

What’s also cool… The sec­ondary mea­sures when you mea­sure your Elephant’s Paycheck direct­ly relate to the impor­tant aspects of retire­ment. Questions like: What will your raise be year after year? Will it beat infla­tion? Great ques­tions, and eas­i­ly answered when you invest with a focus on income. These ques­tions will help you plan for a suc­cess­ful retire­ment.

It’s not just smart retire­ment plan­ning either. It’s fun to real­ize that you’ve got a pay­check in retire­ment that will out­pace infla­tion AND replace the pay­check you get from your job. Even if you want to keep work­ing. I mean, who does­n’t like an extra income?

June 12^th, 2013. The NY Times pub­lished a fol­lowup post due to the vol­ume of fol­lowup com­ments to Sunday’s orig­i­nal post. It’s worth a read and high­lights the use of div­i­dends. Though, it miss­es the key point of reduc­ing income risk by under­stand­ing a com­pa­ny’s div­i­dend growth rates over time as a way to keep pace or beat infla­tion.