3 Answers You Must Have to Free Yourself from Dependence on Your Paycheck
Most dedicated savers we’ve worked with reached a unique inflection point in their lives where they which I call the paycheck dependency threshold.
After decades of working, raising a family, putting their kids through school, and saving a large percentage of their earnings, they all paused, reflected, and asked themselves three very important questions:
- “Do we have enough in our retirement portfolio to stop working if we choose to?”
- “How much can we afford to spend without running out?”
- “How do we manage our retirement portfolio to make it last?”
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If you don’t have full confidence with 100% certainty in your answers to these questions, then it’s highly likely you will go down one of two paths:
- Path One: You will continue to work longer than you need to because you think you have to when in fact you may not, or
- Path Two: You will stop working and “retire,” but because of your fear of making a mistake and running out of money, you will have unnecessary anxiety and “pull your punches” by restricting your spending and end up living like far too many deserving folks who say, “I can’t afford that. I’m on a fixed income now.”
Unfortunately, two couples with the exact same level of savings can receive completely different answers to those three questions. Here’s why …
No Reliable Rules of Thumb
Let’s take a look at two couples as a hypothetical example, Mike and Mary, and Ron and Rose, all age 62. To keep it simple using round numbers, assume each couple has:
- $2,000,000 built up in their retirement portfolios,
- the same monthly Social Security retirement income of $4,000, and
- the same monthly pensions of $3,000
From a quick glance, they look exactly the same and would likely receive the same advice if they called into a financial talk radio show.
That would be a terrible mistake, so let’s dig a little deeper to discover what else we know about them:
Mike and Mary have no mortgage or home equity line of credit, and they recently completed many major upgrades to their home, i.e. a new roof, indoor and outdoor paint, a new furnace, new kitchen countertops and cabinets, and remodeled bathrooms. They purchased new cars with cash in the last two years which they plan to drive for 10 years.
Ron and Rose still have $300,000 outstanding on a second mortgage they used to pay for their kids’ college tuition, weddings, cars, and a condo in Florida they bought a few years back. They both drive high-end cars which they replace every three years. And, while their home is very nice, after 26 years, it is starting to look “tired” and will need significant upgrades in the next two years.
Even though both couples have the exact same level of savings in their retirement portfolios and the same amount of income from Social Security and pensions, their situations are drastically different because it will cost much more to support Ron and Rose’s desired lifestyle.
In other words, Ron and Rose are much more dependent on their retirement portfolio than Mike and Mary. This is the first of four numbers you must know if you want to free yourself of your dependence on your paycheck, i.e. over and above income from Social Security, pensions, and rental property, how dependent are you on your retirement portfolio?
Before we delve into the best way to calculate your level of dependency on your retirement portfolio, know that this is not about living on a “budget” and restricting your spending. This is about having an “accounting” of what it costs to live the way you want so you can have an accurate and reliable measuring stick to make decisions.
There’s a big difference.
To determine your level of dependency on your retirement portfolio, you have to be very clear on your inflows and outflows. On the inflow side, how much will you receive each month from Social Security, pensions, and rental property (if you happen to own any)?
On the outflow side, what does your ideal lifestyle cost, including “fixed” or mandatory expenses, and “discretionary” (your choice based on your priorities).
Typical “fixed” expenses include utilities, insurance, groceries, clothing (at least most clothing falls under this category), mortgages, real estate taxes, etc. These are expenses that must be paid, and typically they’re paid every month.
“Discretionary” spending, on the other hand, is where we’d like to spend our money, like dining out, vacations, gifts for your grandkids, and entertaining. However, when planning, most folks don’t account for them as much as they should.
Remember, this is all about living exactly the way you want, so be generous with your estimates. If you guess too low, you’re only shortchanging yourself.
The difference between your inflows and your outflows during any given year is your level of dependence on your retirement portfolio, and this is the first of four numbers you must know if you want to free yourself of your dependence on your paycheck.
Stay tuned for numbers two, three, and four in this series.
This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant. Please consult your investment professional regarding your unique situation.
Jack Phelps
Financial Advisor / Managing Director