Everything You Are Being Told About Saving & Investing Is Wrong – Part 3
In Part 1, we discussed the problems with the “savings” side of the equation as it relates to building wealth. Part 2, covered the issues of counting on average, or compound, returns as it relates to future outcomes.
This final chapter is going to cover some concepts which will destroy the best laid financial plans if they are not accounted for properly.
Just recently, CNBC ran a story discussing the “Magic Number” needed to retire:
“For many people who adhere to the mission, there’s a savings target they want to hit, at which point they will have reached financial independence, as they define it. It’s called their FIRE number, and typically, it’s equal to 25 times a household’s annual spending, invested in low-cost, passive stock funds. Many wannabe-early retirees aim to save between $1 million and $2 million.”
This was the savings level we addressed in part one, which is erroneous because it is based on today’s income-replacement level and not the future inflation-adjusted replacement level, as it requires substantially higher savings levels. To wit:
“The chart below takes the inflation-adjusted level of income for each bracket and calculates the asset level necessary to generate that income assuming a 4% withdrawal rate. This is compared to common recommendations of 25x current income.”
“If you need to fund a lifestyle of $100,000 or more today. You are going to need $5 million at retirement in 30-years.
Not accounting for the future cost of living is going to leave most individuals living in tiny houses and eating lots of rice and beans.”
The Cost Of Miscalculation
As noted in the CNBC article above, it is recommended that you invest your savings into low-cost index funds. The assumption, of course, is that these funds will average 8% annually. As discussed in Part One, markets don’t operate that way.
“When imputing volatility into returns, the differential between what investors were promised (and this is a huge flaw in financial planning) and what actually happened to their money is substantial over long-term time frames.”