People often ask how much money they will need to meet their retirement goals. But let's turn this common question on its head: What will $2 million actually get you in retirement? This is an interesting query because (a) many people believe that $2 million is a comfortable amount to meet their retirement goals and (b) it allows us to examine the different ways in which a hypothetical couple can use $2 million without running out of money.
As with any retirement calculation, this one involves numerous assumptions. Nevertheless, as long as the assumptions are reasonable—for example, using 6% for equity returns rather than the 10% figure that many illustrations often include—it's possible to arrive at a conservative estimate of how much money you might need to retire comfortably.
Let's start with these assumptions for our hypothetical couple:
Before generating a retirement plan for this couple, it's important to clarify what constitutes "success" in this situation. Because we live in a dynamic world, especially when it comes to investing, we'll look at this question in terms of probability, using something known as a Monte Carlo analysis, which factors in thousands of scenarios with widely varying assumptions and investment returns in every year. For purposes of this example, we'll define success as a probability of at least 85% that the couple's funds won't run out during their retirement.
Using our assumptions for this hypothetical couple, the Monte Carlo analysis shows a 97% probability that they won't exhaust their savings. That easily meets our definition of success and suggests that they might be able to spend more than $70,000 a year and still succeed, based on the 85% threshold.
So, how much can this couple spend per year and still have an 85% chance of achieving their retirement goals? Running through a few scenarios provided an answer of $81,000. That's the amount they can spend each year and still have an 85% chance of never running out of money.
This raises another question: Is there a way for this hypothetical couple to spend $81,000 annually in retirement while also raising their probability of never running out of money? There are really just two ways to accomplish that, assuming that going back to work isn't a desirable option for them:
1. They could choose investments that deliver higher returns without increased volatility; or
2. They could look for investments that have the same returns, but less volatility.
One potential way to reduce volatility while maintaining reasonable levels of return is to acquire highquality, dividendpaying stocks that have a history of increasing their dividends. If the volatility level is reduced from 16% to 13% per year, based on historical rates, the probability that this couple never will run out of money jumps from 85% to 93%. This significant leap is due to the fact that they are investing more heavily in stable, solid, dividendpaying stocks rather than in investment vehicles exposed to greater volatility.
Of course, everyone operates under a different set of circumstances. You might need to change several things from this basebones example to meet your retirement goals. But it is difficult, if not impossible, to tell whether you will be able to retire comfortably until you sit down and actually run through the numbers. When that occurs, some interesting scenarios may emerge to help you see what you need to do to meet your goals.
Bottom line: Will $2 million be enough to sustain you through your retirement years? We can help you plug in the figures to give you a better grasp of your personal situation and then tailor your plan to your specific needs.
