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In another thread, Kelly proposes the following thought-problem. Can a 75-year old single, with no debts, a $40k lifestyle, and $5 million to invest get by with investing in just Treasuries and win the hand of his corner-café waitress? The answer is “Yes” provided he never spends a penny more (adjusted for inflation) and he doesn’t exceed his average, maximum life expectancy. Otherwise, he’s begging for bread in his final year of life, having totally depleted his grubstake.

Can’t happen? Won’t happen? You can answer this question for yourself and your own situation by doing the following. Build a spreadsheet that allows you to input the following variables: Age now. Age at death. Assets now. After-tax gains on those assets. Average, after-tax living-expenses now. Estimated, average forward inflation-rate. The way to make the numbers work for you is the following:

(1) Under-estimate how long you will live
(2) Under-estimate what your living expenses really are
(3) Under-estimate what the rate of inflation will be
(4) Under-estimate what your tax-rate will be.
(5) Over-estimate what your after-tax gains rate will be.

Then, presto, magic-o. Kelly can marry his waitress, and both can live happily thereafter. But if he uses the published actuarial number of 104 for males, the published inflation-rate of 9.07% (pre-‘82 method), published gains numbers (look it up), and published tax numbers (ditto), he comes a cropper, broke on his death bed, needing $636,746 to live another year, but having only $244,295 in the kitty.

The point of this exercise isn’t who is right or who is wrong about the details, which can be endlessly argued. Rather, the point of such exercise is to test assumptions and to discover the conditions under which the model blows up. Putatively-safe investment vehicles, such as Treasuries will never, on average and over the long haul, provide a real rate of return after taxes and inflation. At best, they enable users to control their rates of loss. Therefore, they cannot be used as a sole investment strategy unless savings are large enough to overcome those losses, plus drawdowns.

What is the median, household net-worth in this country even if real estate equity is included? Less than $260,000. That’s a far cry from the 75-year’s $5 million, but median, house living-expenses aren’t much below $40k. The median, household income is $46,326, and the median household savings rate is 5.3%. Do the math. Most people barely have their nose above water, and they are failing to take on sufficient investment-risk to provide for their retirement. For sure, most people will have multiple income-streams in retirement, only one of which will come from investments. Most people will have a public or private pension, plus Social Security Insurance. So include those in your spreadsheet and run your numbers again. Lower the inflation-rate from the reported 9.07% to what your actually-experienced inflation-rate is. Change your asset allocation from 100% Treasuries to a more sensible 80%-20% bonds to stocks, or to whatever boosts your rate of return without taking on intolerable risks. Cut back your spending a bit. Etc. Etc.

What I’ve found, from building retirement spreadsheets for a lot of years, is three things:
(1) What seems like a lot of money now really isn’t in 20 or 30 or 40 years.
(2) It is very, very tough to match the reported historical investment returns.
(3) For long periods of time (as you stock indexers found out in the past decade), investment returns can be very low.

Run this exercise. Sell the business for $2 million. Keep the after-tax draw at $40k. Drop the inflation-rate to a more realistic 6%. Bump up the after-tax gains rate to 3%. The 75-year now gets to age 103 with a few bucks to spare. But if the least little thing about the plan goes wrong, he and wife are in the breadlines.
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