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.
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.
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 12th, 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.