What Will $1 Million Get You in Retirement?

One Million Dollars
One Million Dollars

By Douglas Carey

I spend a lot of time helping people understand how much money they will need to meet their retirement goals. Today I want to look at that subject from another angle: What will $1 million actually get you in retirement?

This is an interesting question for two reasons: First, because many people believe that $1 million is a comfortable amount to meet their retirement goals; and seconds, because we can look at the different ways in which a couple can use this $1 million without running out of money.

Like any retirement calculation, this one involves many assumptions. But as long as our assumptions are reasonable -- say, 6% for annual equity returns rather than the 10% figure that many people used to use -- we can come up with a reasonable estimate for how much money one needs to retire comfortably.

Let's start with the assumptions I used for the couple we will look at:

Before we attempt to generate a retirement plan for this couple, the first thing we need to clear up is: What constitutes success? We live in a dynamic world, especially when it comes to investing. So I like to look at the probability of never running out of money in retirement using a system called Monte Carlo analysis, in which thousands of scenarios are run to determine the odds of various outcomes. In this case, returns on investment are treated as widely variable (because, as we all know, they are), with the possibility of shocking investment returns in every scenario in every year.

In this example, I'll define a plan as a success if it returns a probability of 80% or better that funds never run out in retirement.

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Under the retirement plan above, I calculated the probability that the couple would never run out of money at 95%. This easily meets our definition of success. In fact, this couple could spend more than $50,000 a year and still succeed: If they spent $55,000 annually, they'd still have an 80% chance of never running out of money.

That leads naturally to another question: What could we do to change the plan so that the couple could spend that $55,000 a year, and still increase their odds of never running out of money?

There are really only two ways to do this since this couple is already retired (assuming they don't want to go back to work): They can find higher returning investments with the same level of volatility they currently have, or they can find investments that have the same returns, but less volatility.

My favorite way to reduce volatility while maintaining reasonable levels of return is to buy high-quality dividend-paying stocks that have a history of rising dividends over time. A few of my favorite dividend payers for retirement portfolios that have consistently raised their dividends over the years are Johnson & Johnson (JNJ), Sysco (SYY), AT&T (T), Walmart (WMT), Coca-Cola (KO), and Eli Lilly (LLY).

In the scenario above, I replaced their Equity Value fund with the stocks listed above, equally weighted. I kept the same total return assumption, but lowered the level of volatility to the historical levels of these stocks. That is, I reduced the volatility level from about 16% to 13% per year.

The result: The probability of the couple never running out of money jumps from 80% to 88% -- solely due to the fact that they are now invested in more stable, solid dividend-paying stocks instead of an equity index fund.

Each person and every couple has a different situation, and might need to change a variety of things in their financial plan in order to meet their retirement goals. But it is usually impossible to tell whether or not you can retire when you want until you sit down and actually run through the numbers. At that point, you can begin running interesting scenarios that will tell you what you need to do to get to your goals.

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