The superior man makes the difficulty to be overcome his first interest; success comes only later.
— Confucius

After reading the preceding series on traditional retirement advice, you might well be feeling like it’s all hopeless. Well, I am here to tell you otherwise. Not only is it possible to build a lifetime of sustainable wealth, it can be done in far less time than you might imagine. What’s more, the essence of what’s required is actually quite simple.

Of course, as I’ve mentioned before, simple and easy are two very different things. When I first lay it out, you may well be tempted to throw up your hands and call it all impossible again, but try to keep an open mind.

The truth is that whether you wish to retire after five years or thirty, there is a plan that can get you there, if you are willing to do what is necessary. [Click to continue...]

Image by Giga Paitchadze

My friend, drop all your preconceived and fixed ideas and be neutral. Do you know why this cup is useful? Because it is empty.
— Bruce Lee

Today we’re going to talk about the 4% rule. This little nugget is so widespread among personal finance sites as to be nearly ubiquitous, in one form or another. If you recall from part I, it’s the rule we used to determine how much money we needed to accumulate to meet our retirement goals.

Simply stated, the 4% rule is as follows: When it comes time to retire, multiply your nest egg by 4%. This amount constitues your “safe” withdrawal rate. In other words, it’s the amount you can supposedly withdraw every year, adjusting for inflation along the way, without worrying about running out of money during your lifetime.

It’s easy to see why this little rule of thumb is appealing. It’s simple, and it offers the prospect of a steady, predictable retirement income. The trouble is that the 4% rule is highly misleading, in large part because of these exact two features. [Click to continue...]

Image by Rudolf Schiestl

An out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor. He said, “Look, those are the bankers’ and brokers’ yachts.” “Where are the customers’ yachts?” asked the naive visitor.
—Fred Schwed Jr.

I’m afraid I have more bad news for you. It seems our estimates are still overly optimistic. Why? Because we have failed to give the Devil his due. After all, in order to match the return of the S&P 500 by indexing, we’re going to have to invest our money with Wall Street, and you had best believe that Wall Street is going to take its cut for giving us the privilege. Someone has to pay for those bankers’ seven-figure bonuses, and that someone is you. [Click to continue...]

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
—Mark Twain

Consider a series of coin flips. We’ll give heads a value of 1, and tails a value of 0. After 10 flips, we get an unsurprising result — 5 heads and 5 tails. The average value of each flip is 0.5, which happens to match the expected value, as statisticians would call it.

Of course you’d never actually “expect” any particular coin flip to have this value, for the simple reason that it’s impossible. It’s a simple example, but the point behind it is an important one — an average result is not necessarily a typical one.

If you recall, in part I of this series, we learned about the CAGR metric. It is considerably more accurate than the simple “average” return. But recall also what CAGR stands for: Compound average growth rate.

There’s that word again. Average. Does its presence arouse your suspicion by now? It should. [Click to continue...]

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
—Henry Ford

If you read part 1 of this series, and thought to yourself, hm, they didn’t account for inflation, congratulations. You’re right. It’s a pretty glaring omission, I know. Everyone knows you have to account for inflation.

I’m sure you know how this story ends, but let’s go ahead and go through the motions, anyway. If you recall, our contribution rate was $1200 per year, from ages 22 to 65. We found out last time that using the more accurate CAGR instead of “average” return, we wound up with a little over $600,000 instead of the $1 million we were promised. Now let’s factor in inflation. As it turns out, the inflation-adjusted CAGR of the stock market from 1900 through 2011 works out to just 6.26%. Heading over to the retirement calculator and plugging in our new 6.26% “real” return, we wind up with only $241,751. Ouch. So much for our million-dollar retirement.

No surprises, here, right? But there’s a problem. You see, this figure is pretty much bullshit as well. To understand why, we need to look into what inflation really is, and how it’s measured. [Click to continue...]