Topic 2- A Hypothetical Example

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In an additional hypothetical example that illustrates the effects of leveraging, we have a husband and wife, again at age 60. They’re in that retirement red zone. They currently estimate needing an additional $25,000 annual income above social security benefits. They figured out what their income gap was, and now they’re going to apply that need for $25,000 into their planning. So the value that they need in six years, assuming they plan to use a 2% withdrawal rate and using the asset allocation model where they’re just going to grow assets and take 2% out each year, is that they take 600,000 and they have to create 1.25 million in six years to retire with enough money to pull out that $25,000 for the rest of their lives. This was the strategy where you had to develop your number to figure out how you could have a defined income.

But, the problem was, is that you didn’t have a defined outcome in your investing. The challenge here is to grow that $600,000 to 1.25 million in six years. Using the rule of 72, or earning a 7.2% interest on that money would say that we double the money every seven years. So we’ve got to average an average. Remember an average is very unattainable when you look at receiving average returns on a market based investment. We have to earn an average of 7%, give or take, for this example. Now let’s assume that they plan to use a 1.5% withdrawal rate on asset allocation. So we’re going to use a little bit less than 2%. Now we have to grow that $600,000 out to 1.66 million in six years. So in other words, longevity could be a factor if they need to use less money because they know they may live longer, we have to get a higher rate of return than 7% in six years.

I don’t know about you, but I wouldn’t want to put my retirement income plan at risk similar to this couple, with these risks assumptions. In summary, we have a husband and wife age 60 that both planned to retire six years from now. Currently they estimate needing an additional $25,000 of annual income above their social security benefits, and their current assets total around $600,000. Let’s apply these numbers now to an income allocation strategy where we split the money into an income bucket and also a growth bucket. A diversified portfolio that we can access at later points if necessary, but an income bucket that has guaranteed income to fill our gap for a $25,000 annual need for a lifetime.