In the financial world, there are often quoted ‘rules of thumb’. A common one is: “If you own your home and have $1 million invested, you’ll be right for retirement.”

Sounds Reasonable, but is it true?

In our last edition, we examined the idea that an income of $60,000 for a retired couple is often considered sufficient for a comfortable lifestyle. We suggested that for those aspiring to have more, income above $80,000 was probably closer to the mark. So how much invested capital is needed to produce this? The answer to this question is a difficult one.

Post the Global Financial Crisis, investment returns have been subdued. Just take a look at the income that 5 year government bonds currently produce.

Country	5 year bond yield
Australia	1.61%
United States	1.10%
Great Britain	0.40%
Germany	0.57%

So, do Old Rules of Thumb still Apply?

While other asset classes can produce better income, low returns have caused concern as to whether old rules of thumb will continue to hold true.

In the United States, there has been a rule of thumb that has stood more than 20 years. This says that a retiree can afford to draw 4% of their initial investment in the first year, increasing with inflation annually. The theory goes that if this rule is followed, the retiree’s capital is guaranteed to last at least 30 years.

This was based on a 1994 study that examined returns on a portfolio over periods going back to 1929. The assumption was that the portfolio owned 50% in US Bonds and 50% in US shares. The testing showed that even in the very worst 30 year period, the retiree would not run out of money, if they stuck with the 4% rule.

Given the low US Bond yield, some US commentators are suggesting that the 4% rule should become a 2.85% rule. This would mean a retiree with $1 million can only afford to spend $28,500 per year. It would also indicate that to reach the suggested $80,000 retirement income, a retiree might need as much as $2.8 million invested!

Should Investors Lower their Expectations?

At Elston, we don’t agree that investors should set their return expectations quite this low. It is unwise to assume that the current (extreme) situation will persist forever. Interest rates are unlikely to stay at today’s levels; just like they didn’t stay at the heights reached in the 1980s.

Typical Australian retirees often have what is referred to as a ‘balanced asset allocation’. This is made up of 30% in cash and bonds, and 70% in shares and property. In the current environment, an average gross income of 4.10% would be produced using this strategy. This is not as conservative as the 50/50 split used in the US study.

We should also consider that over the long run, the shares and property in such a portfolio should allow the income and capital to grow with inflation. With these assumptions, to have $80,000 pa indexed to inflation with money lasting 30 years, you might need at least $1.565 million. This assumes no age pension is available.

What’s your ‘Magic’ Number?

If we come back to our original question – is $1 million enough, the answer is – it depends. Rules of thumb make good discussion points for articles, but actually should never be used to plan a retirement. Instead, you need to consider your personal situation and goals.

Factors such as desired lifestyle, the legacy you want to leave, the possibility of accessing an age pension, how long you might live, and your comfort with investment risk, all play a big role. So, while $1 million may be plenty for some, for others it will simply not be enough.

To better understand your number, speak to your Elston adviser.

If you would like more information, please call 1300 ELSTON or email info@elston.com.au and an adviser will be in touch.