How much does it take to retire? Conventional wisdom once suggested if you could put aside a million dollars, you’d be set for life when you were ready to kick back.

That’s a faulty assumption, says financial advisor David Sandstrom. First, a million dollars isn’t what it used to be. But more to the point, as a rule-of-thumb target, it’s simplistic and could lead you astray.

Sandstrom is a vice president and general securities representative at Landaas and Co., a Milwaukee-based investment advisory and planning firm.

Of course, this column can never substitute for a conversation with your own financial advisor, who can bring an understanding to your personal circumstances. What follows are general suggestions — not investment or financial management advice.

 

The Inflation Factor

The first flaw in the million-dollar theory is that “over time, inflation has eroded that million dollars to something that is probably not going to be a major windfall for everybody,” Sandstrom says.

Your nest egg should be large enough that you’ll never need to tap into it. “We usually look at a rule of thumb that says, ‘I don’t touch the nest egg, and I live off what the nest egg can produce,’” Sandstrom explains.

And that, too, needs to be more than you might think. You really should live off only part of the annual earnings, and plow the rest back into savings.

Here’s why: With a balanced portfolio — say 50 to 60 percent stocks and the remaining 40 to 50 percent in bonds — historical averages suggest you’ll see an annual return of about 7 to 8 percent.

Now, consider that inflation has been about 3 percent a year for a long time now — sometimes a little less, sometimes a little more. To keep pace, the dollar value of your annual payout actually needs to go up every year. For that to happen, the base savings needs to keep growing, too.

“If you’re going to leave something in there for inflation every year, so that you can give yourself a little raise, that would probably leave about 4 to 5 percent for you to spend,” Sandstrom says, not the full 7 or 8 percent. “If you spend all of the return, you’re stuck with that million bucks the rest of your life. You’re not going to keep up with inflation.”

Sure, you’ll get $70,000 to $80,000 a year in income — but in 20 years, that won’t buy you as much as it does now. So if you’re starting with $1 million and hold back part of your earnings to build your savings up, you’ll only be able to take out about $40,000 to $50,000 to live on in that first year.

Only you can decide if that will pay your expenses comfortably. But unless that’s what you’re already living on, chances are the answer is no.

 

A New Approach

Besides the impact of inflation, some costs will rise considerably once you’re retired. Yes, some expenses may go down. Perhaps you’ve paid off a mortgage, you’re driving to work less, or maybe even trimming your clothing budget. But other costs will go up, Sandstrom warns. No. 1 is health care: “Health care costs are becoming a very significant hurdle for people retiring, especially if they retire prior to going on Medicare.” (So much for taking early retirement at 55, 60 or 62.)

Another culprit: Your savings — that nest egg — carries a lot more of the burden of supporting you in retirement. Traditional pension plans are vanishing, for one thing. Or, as Sandstrom puts it, your retirement resources “used to be Social Security, a pension, and whatever you’ve saved. Now it’s pretty much gotten down to Social Security and what you’ve saved.” And for most people, “Social Security is not an answer for retirement. It’s a supplement.”

What all this adds up to is a completely different approach to calculating a retirement target rule of thumb. And it’s not a one-size-fits-all number.

So how do you set your retirement savings goals?

“We ask clients, ‘What’s your number? What do you need a month?’ It varies so much across the board,” Sandstrom says. “I have people who do fine on Social Security alone every year, and I have people who spend all their Social Security every month and draw lots of money out of their portfolio — and they complain about not having enough. It all depends on the individual.”

 

Once you have calculated what you think you’ll need to live on per month, plan “well in advance with those numbers in mind,” Sandstrom says. Ideally, you’ll want to save enough so that skimming a little more than half of the earnings off every year — that 4 to 5 percent — will provide you with enough income.

 

Where to Stash It

When you’re ready to tap into it, where should you put that savings? That question is complicated by the historic low interest rates over the last decade or more — great for borrowers, but not for savers. That’s pretty much undermined a longtime traditional retirement savings parking place — the bank certificate of deposit.

“Thirty years ago, CDs were double digits, and it was pretty easy to have a really safe portfolio that paid you a really nice return,” Sandstrom says. Today, “The safer stuff that you’d like to own in retirement doesn’t pay you anything,” which “puts a little bit more pressure on what that number is for your nest egg.”

Maybe simple, safe, high-interest savings instruments will come back someday, but don’t expect them any time soon. So the nest egg needs to be big enough to allow for some higher-risk, higher-return investments that can deliver a potential windfall. But if those collapse, you don’t want them to undercut your long-term plan.

Sandstrom suggests maintaining a broad portfolio balanced between a level of risk you can tolerate and a level of security you can maintain over time. Make sure some of your investments are in “something you’re just drop-dead positive” will provide steady earnings at low risk — high-quality bonds, for instance.

Then, if the riskier part of your savings hits a rough patch, you can afford to leave it alone until it recovers and tap into the safer side of the portfolio. “Just don’t spend assets that have just been discounted.”

 

The Bottom Line

To sum up: Forget about a $1 million target. “It’s not the million dollars. It’s having a plan,” Sandstrom points out, one that will let you draw on your savings that amount you’ll need each year for the rest of your life. “Get a good handle on what you think your retirement needs are going to be, then figure out, ‘Can I get there?’”

Consider it a road map that will lead you to that retirement lifestyle you’ve been dreaming of. Then see what you can do to make the trip as smooth as possible.