Harder Than Building Wealth: Keeping It

聚財容易守財難

It's easy to get rich -- but it's mighty hard to stay that way.

Want a hefty retirement nest egg? With regular savings and reasonable investment returns, even ordinary investors can garner surprising wealth.

That wealth, however, probably won't last. The fact is, it is tough to keep a nest egg intact through a long retirement, let alone preserve it for multiple generations.

Amassing Cash

Most folks, of course, reach retirement with precious little saved. But if you are determined to accumulate wealth, it isn't inordinately difficult.

Suppose your income is $60,000 and you sock away 15% of your pretax income every year for 40 years. At retirement, you would have almost $900,000. This assumes a 4% annual investment return, which might seem modest, but I am also assuming 0% inflation.

To have a good shot at earning that sort of return, eschew the foolish pursuit of market-beating performance. Instead, sit quietly with a mix of low-expense stock- and bond-index funds. That way, you will capture the underlying markets' performance without losing much to investment costs.

In truth, if you sock away 15% of your income every year, you will likely end up with far more than $900,000. The reason: If you stash savings in your employer's 401(k) plan, you might snag a matching contribution, which could be worth 50 cents for every $1 you invest.

Slipping Away

But easy as it is to amass wealth, it's hard to hang onto. At some point, you will retire -- and that's when the math turns ugly.

Let's say you quit the work force with enough cash to cover your first year's expenses, plus you also have $1 million in stocks and bonds. You reckon your investments will clock 7% a year, while inflation runs at 3%.

That first year, your portfolio would grow to $1,070,000. If you then withdrew $40,000 to cover your second year's expenses, that would leave your portfolio up 3% at $1,030,000. In year two, you would earn 7% on that $1,030,000. That means you could withdraw $41,200 at the end of the second year -- a 3% increase from the prior year -- and still have a portfolio worth 3% more, or $1,060,900.

Result? It seems like you've achieved a neat trick. Both your portfolio and the income it generates are keeping pace with inflation.

Yet this trick isn't as neat as it seems. You can't be sure you will earn a steady 7% or that inflation will hold at 3%. Moreover, investment costs will eat into your performance and then taxes will take a bite out of whatever remains.

Maybe more important, the whole strategy overlooks a fundamental problem: Even if you could collect a stream of income that rises with inflation and even if you could maintain your portfolio's inflation-adjusted value, you aren't holding your own. Instead, you are falling behind.

How so? While the cost of living may rise with inflation, the general standard of living rises somewhat faster, as a growing economy drives up salaries, wages and other sources of personal income. Typically, incomes climb roughly two percentage points a year faster than inflation, so that if inflation runs at 3%, the general standard of living might rise 5%.

Suppose, once again, that your investments notch 7% a year. If you want both your $1 million portfolio's value and the income it generates to match the general standard of living's 5% annual increase, you would need to limit your first withdrawal to a mere $20,000.

What if you spent more freely? If you withdrew $50,000 at the end of the first year and thereafter increased annual spending at 5%, so your lifestyle kept pace with the general population, you would have a wonderful 26 years.

And then you would be broke.

Learning Lessons

Fortunately, for most retirees, that dreaded moment never arrives, because they are more cautious with their spending, so their money lasts longer than they do. In all this, there are three key lessons.

If you are retired and you feel like you aren't keeping up with the Joneses, there's a reason: You probably aren't. Even if your income is increasing with inflation, you are still falling behind most other folks.

This slippage likely won't seem like a big deal, except for those who take early retirement. If you quit the work force in your 50s, you might spend four decades in retirement -- and your standard of living could start to seem distinctly inferior.

Even if the estate tax disappeared, family fortunes will always be difficult to preserve.

If the beneficiaries try to live off the family's wealth, that wealth and the income it generates won't grow along with the general standard of living unless family members are content to spend only those gains in excess of the national growth in personal incomes. That's unlikely to happen unless the family fortune is huge or the beneficiaries are awfully parsimonious.

This highlights how valuable our 'human capital' -- our ability to earn income -- really is. While we are collecting a paycheck, our standard of living should climb as the economy expands. Once we retire, keeping up becomes far tougher -- unless we're willing to spend down our savings.

Jonathan Clements