Rich People

Rich people always get blamed for stuff that isn’t their fault. Or, depending on who you ask, they always get away with everything that is their fault while other people take the blame.

And to make things even more complicated, you’ll also find a lot of conflicting definitions about who’s rich and who isn’t.

Some say that you can identify a rich person by the six-figure income. Others would say it’s the seven-figure net worth. Some would gauge your wealth by the size of your home, the quality of your car, or the person who designed your clothes.

I’ve been to Kenya and they use different metrics there. It usually involves donkeys. To quote my friend David Muchai, a lifelong citizen of Kenya:

“Look at this man over here. He has two donkeys. He is very rich.”

Or later: “That man has one donkey. He is doing well.”

And finally: “Look at that man pulling his cart. He is poor. He doesn’t have a donkey. He is using human donkey.”

Here’s a couple of fun facts about Muchai that have nothing whatsoever to do with our discussion today. First of all, he loves Kenny Rogers. I’m still not sure why. Also, he always wears a Chicago Bears hat. Asked him once if he was a big Bears fan. He shrugged, “They are the ones that send the hats.” I’m pretty sure he’s never seen a football game.

In any event, it’s hard to get a consensus on who’s rich and who isn’t. So, perhaps it’s helpful to clarify what a “rich” person looks like when it comes to retirement planning. Consider the following two clients:

Client #1: Husband and wife combined make about $85,000/year. They have just over $350,000 in savings and they plan to retire in the next 3-4 years when they both turn 66. They’ll need a gross income of about $5,000/month to maintain their lifestyle and also enjoy the traveling that they want to do once they retire.

Client #2:  Husband makes about $250,000/year, wife doesn’t work. They have a little more than $2 million in savings. He’s 58 and wants to retire at 60. To achieve their desired lifestyle, they’ll need about $14,000/month in gross income, plus another $10,000/year for travel.

So which of these clients is wealthy?

Client #1 is, by far, the wealthier of the two.

Contrary to popular thinking, I don’t measure a person’s wealth by how much money they have or how much they make. It has much more to do with the ratio of their assets to their spending.

Let’s think about situation #1. They’re going to retire at full retirement age for Social Security. They both earn an income (and both have for 40+ years), meaning they’ll both have a decent Social Security benefit since they’re waiting until full retirement age to start taking it. In fact, their combined Social Security benefits will account for $4,350 in monthly income.

That means we’ll need an additional $650/month to meet their needs. This means drawing down about 2.2% of their portfolio each year. Very realistic and easy to achieve. They could actually retire a year earlier than they planned and be just fine.

On the other hand, the gaudy salary and account balance touted by Client #2 doesn’t mean that they’re in great shape. He wants to retire at 60, which is two years before he can start Social Security. That means that all of their income in the first couple of years will need to come from savings.

This means a drawdown rate of 8.9% in the first couple of years. Completely unsustainable!

We also have a catch-22 with Social Security. If we start it at age 62, he’ll be getting $2,150/month. Add in a spousal benefit for her (which is equal to half of his benefit) and we have a household total of $3,225/month. Now the drawdown rate on the portfolio is still 6.9%. Still way too much.

Suppose we wait to start Social Security at a later date. Sure, we’ll have a larger benefit, but that also means more years of drawing down that portfolio at a rate of 8.9%. The portfolio will be cut in half by the time we start Social Security.

Unfortunately, our society is much too conditioned to focus on total assets.

Client #1 always says they need to work until they’re 70, because they’ve always been under the impression that “you have to have a million dollars to retire.” I meet with them twice a year to remind them that they’re in great shape, but I’m still not sure they believe me yet.

Client #2 was incredibly confident in his plan to retire at 60, and it took several meetings to convince him that this was a bad idea. He couldn’t fathom that his $2 million dollars wasn’t going to be enough and he was certain that something was wrong with my math. But after seeing the numbers in black and white, it finally started to sink in. Realistically, their options are either for him to work longer than he’d planned, or make some significant changes to their lifestyle. Or maybe a combination of the two. They haven’t exactly decided which of those unpleasant options they’ll choose, but at least they now know what’s realistic and what’s not.

Here’s the bottom line. Don’t make assumptions about your financial health, one way or the other, until you have a clear understanding of what metrics are important.

Unless you have two donkeys. In that case, all is well.