Do You Know Your Retirement "Number"?

Have you ever seen the TV commercials with people strolling through town or the neighborhood carrying their retirement number? The numbers vary from person to person, but the general range seems to be between $1 million and $2 million. The implied message: "Shame on you if you don't know your 'number'!" (And of course, "Contact us so we can help you figure it out.") (See also: Financial Independence Is More Than Just a Number)

I like the ads because they focus our attention on a measurable retirement goal. But what exactly is the goal, and what role does this "number" play?

Assets? What Assets?

The number in the ads might represent total assets (the combined value of your house, savings and retirement accounts, and other things of value). Or perhaps it refers to only your investable assets (just the savings and retirement accounts, not the house). Still another possibility is that it represents your net worth (your total assets minus your total liabilities, or debts). Hmmm.

High Net Worth Is No Guarantee of Financial Independence

If I were to guess, I'd say it represents your net worth. But here's the problem — net worth is a measure of your wealth. That's an important measure, but your ultimate goal is really financial independence, and that's measured by monthly income, or cash flow. Let's look at an example to illustrate.

Assume your household has a net worth of $1 million. Congratulations, you're a millionaire! Surely that's enough to retire on, right? Maybe…or maybe not. It depends on the composition of your net worth.

If, for example you have $2 million in assets but $1 million in liabilities (mortgage, auto, education, and other debt), your net worth is still $1 million. But the cost of carrying so much debt might be, say, $6,000 per month. Despite being a millionaire, can you afford to give up your job and still cover a negative monthly cash flow of $6,000? And we haven't even addressed your other monthly cash flow needs to cover food, clothing, transportation, energy, health care, and other living expenses.

Cash Flow Is King

This example is a little extreme, but it illustrates a very real point: Your ultimate goal — your retirement "number" — should be measured not by wealth but by cash flow. Yes, your wealth contributes to your cash flow, but it's a means towards the end and not the end itself. And as illustrated by the example, there is bad wealth (which generates negative cash flow) as well as good wealth (which creates positive monthly cash flow).

Let's try another example, one that moves us in a more favorable direction. Your household has $1 million in assets and no liabilities. Great — no negative cash flow from loans. But your house is valued at $600,000 and your total retirement savings is $400,000. If you invest the $400,000 in an account that generates 6% annual interest, that's $24,000 per year or $2,000 per month in positive cash flow. Ah, but the house. While it's mortgage-free, the insurance and property taxes create a regular stream of negative cash flow. And then there are still those nasty cash outlays for living expenses.

OK, you've made some progress but haven't yet reached the promised land of financial independence. So let's give it one more try.

You have no debts, $500,000 in retirement savings, a primary residence valued at $250,000, and a two-family property also worth $250,000 that generates net positive cash flow of $1,200 per month. Now let's see where you land. Positive cash flow from retirement savings (at 6% return) = $30,000/year or $2,500/month. And if you apply $700 of the $1,200 monthly cash flow from your rental property to pay taxes and insurance on your primary residence, you net a positive $500/month from that "good" rental property asset.

So now you've managed to clear $3,000/month even after the monthly carrying cost of your real estate. If that's enough to cover your monthly living expenses, then you're on your way to financial independence. Add in social security and other supplemental sources of monthly income and you might even have a cushion to cover occasional lump sum purchases and unexpected expenses. Nice going!

As with any good plan, a retirement plan starts with a clearly defined goal. After all, without one, how do you measure your progress or success? Unfortunately, this part of the retirement planning process is often lacking. Yes, accumulating wealth plays an important role, but it's a supporting role, and it's not the ultimate goal. The ultimate goal is financial independence, and that's measured by a different "number" — monthly cash flow.

Do you have a retirement planning goal? What "number" do you use?

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Guest's picture

It's all about your expenses. You need 20x expenses to live in perpetuity. Get your annual expenses, multiply by 20, and that is your number. Nothing much hard to it!

Guest's picture

what is this witchcraft math?

Guest's picture

I am still in my 20s so I know the total amount of money I will need to have saved by the time I retire will be a lot different due to inflation than the number it is now. I am preparing for this by investing my money in a mutual fund as well as a retirement fund. Essentially I plan to just let the money sit for the next 40 years as I invest and put away more money. In a few years or so after I have gained enough financial knowledge, I will try to come up with a goal, but right now I have a plan worked out to stash away as much money as I can.

Guest's picture

I took early retirement eleven years ago (bought 5 years of time, cost me $35K+). However, my financial adviser must have been correct because we're still living within our income in the same house, still own two cars and financially help the struggling kid. We also support five cats with large monthly vet bills. So far, we've been living on our retirement and SS and have not had to dip into the investments we've made. So, guess we did something right. By the time we retired, we were both socking away 18% of our gross income in our 457 accounts. When the stock market crashed, we lost over $45K. That hurt but I think we'll still be okay. We didn't seriously start saving until we were in our 30's so . . . start sooner if you can and save as much as you can. Then, you retire and deal with reality.

Guest's picture

The only problem that I see with the second scenario is that withdrawing 6% from your acount every year would draw down that account rather quickly. You would have to reinvest half that amount ~3% in order to combat inflation.

Guest's picture

Agree! I'd like to add that $1m is hardly likely to be enough, largely due to the effects of inflation:

If you're starting out now, then in 40 years time, when you retire at 65, inflation will have roughly halved the 'buying power' of $1m twice!

That means, that $1m then will only 'buy' you roughly what $250k buys you today.

If you use a very generous 4% annual withdrawal rate, that means a 'safe' standard if living in retirement of just $10,000 p.a. ... and, that assumes you don't have to use some of the $1m to pay off your mortgage!

Even if you retired today, at 4% that $1m buys you an annual standard of living of $40,000 but, you have to realize that the market often zigs when it should zag, and you really should reduce that down to, say (& this is not an exact 'science'), $20k to $25kp.a. ... IF you want your money to last as long as you do ;)

Guest's picture

Positive cashflow beats anticipated returns on investments every day of the month. It's the upfront costs and time it takes to generate cashflow investements vs. retirement accts. you have to be aware of. I've been a Landlord for 7yrs now so I can speak from experience.