On Saturday morning, I woke up to an email from a long-time reader of this blog. To preserve anonymity, let’s call him Carl.
Carl sent me a link to this story from the Sunday Times and asked for my views.
I was still in bed, the title – and the picture of a sun-drenched pool – were catchy enough, and so down the rabbit hole I went.
For those of you as intrigued as I was, you can read the article for free with a trial subscription. For everyone else, the author (as the title suggests) was trying to bring home two key points:
Point #1: A £1m pension pot is well within reach for most people
Point #2: A £1m pension pot is nearly not enough to be a “wealthy” (whatever that means) pensioner
Sadly, the rest of the article was a mish-mash of unrelated pension facts, investing advice, and a sprinkle of quotes by financial industry “experts”.
In other words, your typical financial press junk food – a waste of time and bad for your (financial) health.
That being said, I thought the two core points were interesting enough for a proverbial double-click in today’s post.
When it comes to life, it usually makes sense to aim as high as possible. Even if you land short, you’ll still end up in a great place – and our finances are no exception.
Hence, I am actually in broad agreement with the author on the fact that achieving a £1m pension pot isn’t as unrealistic as people think it may be.
In fact, these three pension millionaires can give you a realistic blueprint on how to hit the seven-figure mark in your retirement portfolio:
No, you don’t need to be a banker or a lawyer. That being said, life also has a habit of throwing curveballs our way.
It can be a stint of unemployment or a health issue. Some folks end up making a bad financial decision or two. Divorces are far from rare. Few people are lucky enough to get through life without a bump in the road.
For many others, it unfortunately boils down to a simple lack of financial awareness. If, for whatever reason, you haven’t paid attention to your finances early on, you may find yourself out of runway for your investments to compound.
The chart below is a helpful reminder of how much difference a couple of decades can make:
Start at the age of 25, and you need to contribute a grand total of 149k over 40 years to join the millionaire club. Delay until you hit 45, and the price of admission goes up nearly threefold – a neat $420k over 20 years.
Which is to say that if you are young, employed, and reading this article, a £1m pension is well within your reach. But does it really mean you’ll be able to live it up in retirement?
The World £1m Pension Is Not Enough
According to the Sunday Times, “a £1m pension pot would buy a 65-year-old an income of £17,580 if they bought the best annuity on the market”.
I haven’t checked, but the number looks directionally correct – and it’s not necessarily that the annuity providers are trying to take advantage of us (though there is some of that, too).
It’s also fair to say that £17k a year is a far, far cry from putting a bottle of Veuve and caviar on your brunch menu once you punch out of the workforce. It’s fair to say that for £1m, it’s an absolute pittance. What is the point of making all that effort in the first place?
The sad reality is that a combination of longer life expectancies (c.83 years of women and 79 for men) and historically low bond yields have decimated guaranteed returns we can get on our money.
But the point that this – and countless other – retirement articles ignore, is that the above scenario represents just one possible outcome. In search of that guaranteed income, they’ve implicitly traded away all the upside.
So what’s in it for you if you are willing to take on a bit more risk?
The next step up on the ladder is the safe withdrawal rate, a concept so popular in the financial independence community.
As a reminder, some very smart people have figured out that you can safely withdraw 4% of your investment portfolio without running out of capital.
To accomplish this, however, you need to leave your entire portfolio invested in the stock market (so that it can continue growing). In addition, there’s a big debate as to whether the 4% should be reduced to account for today’s anemic economic growth.
The point, however, is that even if you drop the SWR to 3.5%, you’d still end up with £35k a year, or double the grim prediction of £17k annuity income as set out above. Not too shabby.
But that’s not where it ends.
Risk… And Reward
The reason there is so much debate about the 4% rule is that many folks who strive for financial independence also want to get there early.
As a result, they’ve got much longer “retirement” horizons to plan for.
Often, they plan with a forty or fifty-year time horizon in mind – and prefer to err on the side of caution to avoid running out of money.
For a “normal” retiree punching out at 68 today, the retirement horizon is much, much shorter. Assuming the actuaries have done their homework, it’s about 12 years for men – and 15 for women.
Which is to say that even in absence of any growth, a £1m portfolio can generate an annual income of between £67k and £83k per year, depending on your gender.
If you are feeling particularly sprightly, you may want to plan for a twenty-year retirement. The bottom line, however, is that few of us will live to see 90. Like it or not, but statistics will see to that.
Is it a grim way of looking at things? Perhaps. But if one thing is certain in life, it’s that it will come to an end for all of us.
And in my books, there’s nothing as grim as spending your entire life working and saving up – only to be denied the fruits of your labour in retirement.
At the end of the day, we all find our perfect place on the risk-reward spectrum. Some folks will gladly take the £17k annuity for the peace of mind of never running out of money.
For those with a bit more risk appetite, there are plenty of other options on the table. Don’t let the Sunday Times, or anyone else for that matter, tell you otherwise.
Thank you for reading!
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
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