Wealth Building Lessons

A recent articl,e Is $1 Million Enough to Retire On?, got me thinking. According to the article, the average American thinks that retiring on $1 million is more than enough.

However, living on a $1 million isn’t what it was a few decades ago. It will only generate between $40,000 and $50,000 a year in income. Assuming that your house is paid off and your kids are independent, that sounds like a decent amount to live on.

The article quotes a financial planner advising putting $800,000 in an inflation-protected annuity that pays out $45,000 a year. Seems like a decent plan. Especially when you add in Social Security benefits and Medicaid. (Lets ignore the $30,000 commission the planner just made on that sale )

But, the real killer in this article is inflation. I’ve long held the belief that the government reported inflation statistics are wrong, and any investment that is purportedly indexed-inflation will most likely see its value severely eroded over long periods of time.

Despite the governments assertion that inflation is at 3%, inflation has been running about 10% per year since 2005. Almost everything i buy has gone up 30% in the past 3 years.

I came in to this country 10 years ago. since then:

• Movie tickets are up 100%.
• Gasoline is up 400%.
• Tickets to amusement parks/zoos are up 30-100%.
• Lunch at the food court is up 63%.
• Rent is up over 50%.
• Health insurance premiums are also up. I’m not sure how much because I’ve aged 50% since then and that also affects premiums, but I read somewhere that they up 100% too. (But that’s unverified information, so you can take it or leave it.)

Of course, if you exclude housing, energy and health costs there’s a lot less inflation. I don’t know that one dude who lives in a cave in South Dakota, grows his own food, is completely off the grid and who never falls sick, but I think everyone else is seeing some sort of decrease in their standard of living.

Even If you buy inflation-protected annuities, your standard of living is guaranteed to decrease substantially over the next 30 years.It may not happen overnight or for a decade. But it will happen at some point, last for several years, and you will end up in the significantly poorer.

Let’s take the example of my friend’s house that cost $30,000 in 1965 in a suburb of Los Angeles which he bought for $450,000 in 2004. (We’ll ignore the fact that it went up to $675,000 and is now at $550,000 and still dropping). Over a 30 year period, that was a 9.5% annual increase in pricing! At what point were government statistics pointing at 9.5% inflation??? Maybe for a few years in the late 70’s and early 80’s, but I don’t think they were sustained at that rate for the full 30 year period!

And if you’re counting on Social Security & Medicaid to fund your retirement, you’re likely to be even more disappointed. The government doesn’t have enough money to fund Social Security & Medicaid indefinitely. It is estimated that both will be bankrupt by 2027. In reality, they won’t disappear. The government will severely curtail the amounts paid out and they will not really be indexed for inflation. (OK, maybe they’ll be indexed to the fake inflation numbers of 2-3%).

Recently the government reduced Medicaid doctor visit payments to $27. Assuming each visit takes one hour and the doctor employs one nurse at $60,000 a year and a receptionist at $18,000, that works out to $36 per hour(assuming there are no other costs like Social Security Taxes, Health Insurance and Workers Compensation). Factor in rent and utilities, and the doctor is not only working for free, but he’s paying out of his own pocket to see Medicaid patients!

Another faulty assumption in the article is that you only need 80% of your income in retirement. The average American’s saving rate is -2% a year. Put differently the average American is spending 102% of their income a year. What makes you think they’ll be able to live off 80% of it?

If anything, you’ll have more free time and you’ll go out and want to spend more money.

So whats the solution?

As far as I know, there’s only one investment that really keeps up with inflation: Real Estate.

Over the long run, real estate always tracks the real cost of inflation. During times of economic uncertainties, it may lag it substantially (like it will probably do for the next few years), but it always eventually reverts back to the real cost of inflation (regression to the mean). The trick is to be sufficiently well-capitalized enough to last through the lean periods in real estate.
And that can be a definite problem if your over-leveraged and have poor risk management skills.

If you can, you should try to buy 3-4 homes and make sure they’re all paid off by retirement. You can live in one and rent out the others.

I currently own $1 million worth of rental real estate. No, that’s not my networth, because they all have mortgages on them. In 30 years, they’ll either be fully paid off, or the mortgages will be so small relative the values of the homes, that they’ll be meaningless. (I once met an old lady who’s mortgage was $80 a month! I think she had 3 years left on it.) Meanwhile, the homes are appreciating at the rate of inflation.

Going back to our previous example where the property had appreciated 9.5% annually over a thirty year period, I should have $15.2 million when I retire. Before you rush to congratulate me, remember, that in terms of buying power, that will be worth only $1 million in todays’ dollars. And as we saw from this post, $1 million isn’t exactly retiring in style. But it beats a life of boiled cabbage, or having to chose between taking either your medication or a decent meal.

Real estate should be one aspect of your retirement portfolio. Hopefully, you’ll have a large 401k, and have other investments outside of that.

But the key thing to remember is that in these times of cheap and easy liquidity, borrowers are rewarded and savers are punished!

What are you doing for your retirement?

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