“Suppose that a family has $100,000 invested in conservative bonds, yielding $3000 a year: … perhaps the time comes when the family feels they can no longer hold their heads up… unless their daughter goes to a fashionable finishing school. It will be necessary to jack up their income yield to $ 5,500. Their investment man can arrange a larger yield in a jiffy. He simply sells out the conservative bonds and substitutes with riskier securities.” – Fred Schwed
People will always want and need more money, whether they seek a higher-paying job or a better return on their accumulated assets.
It has taken most of us 50 years to understand how detrimental inflation is, even though we have been experiencing it our entire lives.
To combat inflation, we have asked for higher wages and higher rates of return. When I first started working, I was making a minimum wage of $3.35 per hour. Now, the minimum wage in some states is $20 per hour, but that is still not enough to keep up with rising inflation. Because of rising inflation, for most of us, there will never be enough money.
The Asset Problem
Fidelity recently disclosed that it has nearly 500,000 401k participants with $1 million or more in assets in their accounts. This sounds like a good number; however, Fidelity services over 20 million accounts. Thus, only about 2.5% of all the participants have $1 million accounts.
The problem with a large 401k, IRA, or other investment account is the chance of insufficient money. People will try to squirrel money away, but there will be constant pressure to make that money work more efficiently.
It would be nice to have $1 million in a 401k account until one makes the effort to understand what the money is really worth.
Look at assets as they compete against inflation. If inflation has been growing at roughly 2-3% a year for the last 50 years, then achieving a return of 4% meant there was an extra 1-2% return beyond inflation. This excess return is called real return, which is nice to see.
However, bang! In the blink of an eye, inflation goes from 2-3% to upwards of 9%. Now, the 4% return is actually –5% in real return, so the inflation-adjusted return is no longer positive but significantly negative.
When this happens, there is an asset problem because the saver does not have enough assets to meet their everyday needs and will spend that money faster. This will lead to a greater decline in asset value, which can result in fewer dollars to meet everyday costs and expenses.
Of course, results depend on a stable financial market that never declines and an economy that never has a recession. If you missed the sarcasm, sorry. Both cases are virtually unobtainable unless there is manipulation.
The Problem and Solution
There is a point in everyone’s life when they start to think about how much money they want or need, and $1 million has always been considered desirable. But is it really?
Currently, the average income in the US is about $80,000 per year. If a person were to quit their job, be fortunate enough to have saved up $1 million, and try to live off the assets, they would be able to do that for a little over 12 years until they would need to find more assets or income. (This excludes adjustments for inflation and includes never receiving any return on the saved money. Also, don’t forget that taxes will always be due.)
No one knows how much is enough
In my younger days, I would ask financial advisors how much money they thought was necessary for retirement. To my surprise, most advisors had never thought about this question. Their goal was to get the money and manage the assets, not determine how much they needed to have for a comfortable retirement.
Through research, it was determined that an optimal withdrawal rate must be established. Most financial plans are based on a 4% withdrawal rate, but what happens when inflation is greater than 4%? The withdrawal rate will have to change to keep up with rising costs, or a higher return is needed, which will require more risk.
Is there a “Magic Number”?
Someone who has $1 million in their retirement account could produce a return of 4% and withdraw that amount every year, giving them $40,000/ year. People will supplement this dollar amount with Social Security (projected to be depleted in 8-10 years) and hope for the best. Sooner or later, they would get into their assets to make ends meet, and the great withdrawal would begin. As we see, if the average salary is $80,000/year, a $40,000 income withdrawal along with Social Security is going to cover about 75% of the average wage; therefore, more money will be necessary to avoid dipping into more of the savings,
People who have $2 million would be able to generate $80,000 per year at 4%. But how do you get the money if the average income is $80,000? It is either save, save, save, pray, pray, or work, work, work.
It all seems like a virtuous cycle that can never be enough to be able to keep up. The system rewards those with assets, but learning to compete is a way to succeed. If only 2.5% of accounts in Fidelity 401(k) plans are worth $1 million, then each person should try to focus on their own wealth accumulation. They do not get consumed by everyone else’s values but want to ensure they will have more than necessary to combat rising inflation and economic turbulence. The magic number is what works for you to take advantage of the system to make sure there will be ENOUGH FOR YOU.
Break the Change