5-5-5

A Retirement / Investment Strategy Worth Considering

In the last article, the concept of “permission to spend” was introduced. But how do we give ourselves permission to spend?

My proposal, and what I intend to live myself, is a 5-5-5 strategy. Here we will assume that you have invested a non-trivial amount of money in preparation for retirement.

A fundamental for this strategy is the assumption that your basic costs of living are covered by other sources than your investments. Not everyone is going to fit this model.

Here in the USA, Social Security is often relied upon to fund our retirement. Some may call this socialism, others may call it shifting of responsibility, others may just point out how poorly Social Security has been implemented.

How much you get from Social Security is based on how much you paid in (aka how much you earned during your career). This means that those earning below median income probably won’t get enough from Social Security to afford the basics of life (food & shelter). These are the people least capable of investing but also those who are in most need of it!

If you are young enough that you haven’t looked at the numbers (or haven’t checked the Social Security website for your personal projection), my SS will be roughly 33% of what I’m earning at the end of my career (which extremely unusually is half of what I was earning in my 20s! But as I’ve said and should be obvious, I’m not exactly an average person).

Can you live on 33% of your income?

Whether or not this is before or after tax money is a bit complicated but most likely only 85% of your Social Security will be taxed and you’ll be at a lower tax rate. You might want to use 12% tax as a rough guide. So if you get $36,000 per year for Social Security, your after tax amount that you could budget with would be $32,328. Unless you’ve fully paid off your mortgage, that probably “isn’t enough to live on”.

Thus a major factor to comfortable retirement is setting yourself up with low expenses. This may mean moving to a state with lower property values. This is what I have done. My goal was to have my cost of living be well below how much I will be paid by Social Security (plus my pensions).

“Wealth is what you have minus what you want.” - So to be wealthy, want less!

Now, let’s say you have accomplished this, admittedly difficult situation, and have your expenses below your fixed income (Social Security & Pensions). Now what do we do with that pile of money you have invested?

My suggestion is that your aim is for at least a 15% annual return, obviously it’s better to earn 25%, but from what I’ve seen few people have been able to match that success long term. So let’s assume you are successful at earning 15%.

Take 5% and re-invest it to compensate for inflation (otherwise you will be losing wealth over time). Take 5% and re-invest it to grow your wealth (you do want to leave your children with some massive inheritance, correct?). That leaves you with 5% that you have permission to spend.

Ignore actual performance of your investments each year. Some years will be good, others will be poor.

A financial advisor may say you need to have two million dollars saved up in order to retire, but I think with care you don’t need anywhere near that much. Let’s say you’ve managed to accumulate only $100,000. If you take 5% of that, it would be $5,000 a year you could blow on a fun vacation or nice new toy. Obviously if you have more saved you would have more available to spend on silly luxuries.

In my case, assuming I can continue to maintain a greater than 25% rate of return, means that my situation hopefully will actually be 5-5-15 → 5% compensation for inflation; 5% growth; 15% permission to play with / spend on toys and luxuries.

However, I am doing a little bit of the normal advice and shifting some of my investments away from “high risk, high return” into more stable investments. Thus I’m really only planning on 20% rate of return and thus 5-5-10.

Why do I advise a 5-5-5 strategy?

The first 5% acknowledges the real rate of inflation (devaluation of the dollar) is 5.7% not the propaganda numbers the government publishes.

The second 5% acknowledges our human instinct to save and prepare for the future. We are instinctively terrified of “rainy days” in the future. Fear of starving to death is a very powerful instinct! This also addresses our instinctive desire for improvement. We thrive on feeling like we are improving. We are happy if we are losing weight, getting wealthier, buying a nicer car, a bigger house, a prettier girlfriend / wife (this one is the truly stupid one to chase!).

The third 5% gives you permission to spend. Don’t waste the rest of your life “preparing for the future”. Live in the here and now!