Why is there an obsession over not touching your capital at retirement?


All right, I get it; the whole point of building a dividend growth portfolio is to live off your dividend payments. I totally get that. But is this realistic? Would it be the worst thing that could happen if you withdrew from your capital? In an ideal world, you  would never have to touch your capital, but in the real world, this is less likely to happen unless you save 50% of your income during your highest earning years (which means you will not have as much fun as I plan to during the next 30 years ???? ). Let’s explore the numbers to see if you can really not touch your capital at retirement…

A few points first

To illustrate my point, I’ll assume the following metrics in all of my calculation:

  • Investment return: 6%
  • Inflation: 2%
  • Portfolio yield at retirement 3.5%
  • Age at retirement: 65
  • Last day on earth: at the age of 85
  • Time to save money: 35 years (assuming you start saving at 30)
  • Amount needed at retirement: $35,000/year (in today’s dollar)

One last note before we start running the calculations runs; at retirement, your yield on cost (YOC) doesn’t matter. Imagine you have built a portfolio with a book value of $700K, current value of 1M$ and that pays   36K per year in dividend. You can tell yourself your YOC is 5.14% and feel good about it, but the fact is that you receive 35K out of 1M$ value which is 3.5%. Once you retire, what matters is how much is deposited in your bank account to support your lifestyle, not the market value, not the book value and definitely not the yield on cost. You can read more about the yield on cost and its uselessness here.

Also, when you consider a $35K annual income, you will have to factor that you will not receive $2,916 in your bank account each month. The government will come around and take its dues before you touch your money. Therefore, I don’t think that shooting for a 35K/year retirement income is aiming too high.

You can basically play with all the numbers (like increasing your life expectancy or reducing your age at retirement), but the rationale behind the calculations will remain the same. Now, let’s see which scenario makes more sense; living off dividend payments or withdrawing capital to fill the gap between what you need and your dividend payment.

Can you afford to not touch your capital at retirement?

Assuming you don’t want to touch your capital when you retire, you will need to build a $1,000,000 portfolio to be able to retire on a 3.5% yield (assuming the growth rate will cover the inflation afterwards), right?  WRONG! See, this is the first mistake many people make; $35,000 in today’s dollar will not be  worth $35,000 in 35 years! Yeah… I did it on purpose ;-). The first step is to calculate how much 35K will be worth in 35 years. Assuming a 2% inflation rate, this leads us to $69,996.13… let’s make it $70K for calculation purposes.

Therefore, if your portfolio generates a 3.5% yield, you will need $2,000,000 to retire happy. Even at a 6% investment return, you will need to save $17,950 per year to achieve the $2M mark. If you are making $50,000 per year, once you pay your taxes and you achieve you saving rate of 36%, you will not have much money to live on  during those 35 years.

I can understand the idea of sitting on $2M and not seeing this mark ever go under is highly interesting. However, living on less than $25,000 per year for the next 35 years doesn’t sound like a good plan to me. In fact, it doesn’t make sense to me to have to live with less today, to enjoy more money later… especially when you have no clue if you will make it to “later”.

How about withdrawing from your capital then?

If I want to withdraw $35,000 per year from my portfolio but don’t mind leaving $0 behind, the numbers are far less astronomical. In fact, I used a 4% investment return instead of 6% to account for inflation and the result I get is that I only need $475,661, so $476K at retirement to live happily. Even better, my yearly saving requirement is now down to $4,270/year. Not bad huh?

However, there are several downsides to using all of your capital to retire

While the math speaks for itself, it doesn’t tell you  the whole truth. There are several downfalls to consider about withdrawing your capital at retirement.

The first one is to jeopardize your retirement if you hit bad markets at the beginning. Think about those who were unlucky enough to retire in July 2008… they saw their nest egg going down by easily 30% during the rest of the year. If those young retirees had withdrawn capital from their portfolio, this money would never have had the chance to go back up. This could cut a few years off your retirement plan. On the other hand, if you were to withdraw dividend payments only, your plan would not be affected by Mr. Market’s  mood swings.

Second, you can’t aim at an exact life expectancy. Imagine the worst-case scenario; you plan to live until you are 85 but you pass away at 95. The last ten years of your existence will be nothing but miserable. Therefore, it would be safer to use a 90+ life expectancy in your calculations. For the record, if you run the same calculation but for an age of 95 years, you will need $605K… still not too much!

Third, it’s harder to calculate and manage your plan. What could be easier than cashing  your dividend and living off of it? If you withdraw capital from your portfolio, a recalculation of your retirement plan must be done each year to make sure you are still on target.

Fourth, you won’t leave anything behind. I have a wife and three children. My goal is not to leave my children with a fortune if I pass away at age 85+. If I die at 85, my children will be 61, 59 and 54. That’s a little bit late for them if they wait for dad’s money to do something.  If they haven’t done anything for their own retirement by  that time, I’m not too sure they deserve to inherit a fortune! Still, at this point, I could think of my grandchildren and aim at helping my heirs in their financial plan.

Why not aim for half-way?

Between reaching the $2M milestone and saving the minimum to reach half a million dollars at retirement; why not start the good habit of saving now and reach for something at the midpoint? I started working at the age of 23 and I also started to save a little bit from each paycheck at that time.

I’ll be turning 36 at the end of this year and I’ll be showing a total savings of $180,000 (thanks to the lump sum payment I’ll receive from my pension). Therefore, even if I take a “break” from saving for the next 1.5 years to build my business, I will still be very well on track to have over a million dollars when I am 65. I guess this shows you the importance of starting to save money as early as possible.

I’m not obsessed with  not touching my capital at retirement. In fact, I intend to use a good part of the money I save to continue living a fulfilling life once I “retire”. However, I want to make sure that I have enough. For this reason, I started saving early in my life. If there is one bit of advice I would give anybody, it is the following: Start a systematic investment plan in your 20’s and do nothing but increase it when you have the chance. No pauses, no ins and outs, just keep a steady investing plan.

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