The common financial wisdom is that you need to have 25x your annual expenses saved in order to have enough income for the rest of your life. This is what's known as the 4% rule. It's where you constantly withdraw 4% of your net worth to live off of each year. According to past history this has a 95% success rate for somebody who has a retirement of 30+ years.
If you want to be more conservative there is the 3% rule which equates to having 33x your annual expenses saved in order to have enough income for the rest of your life. You wouldn't think 1% would have that much of a difference, but that little 1% is huge and it's created a lot of controversy in the financial planning industry. A 3% rule has a 99.9% success rate (actually 100% but I don't believe in 100% when it comes to human involvement). If you save 33x your yearly expenses, you're virtually guaranteed to never run out of money in retirement. This is the rule of thumb that I subscribe to, except I like to take it one step further.
NO PRINCIPLE RULE
Not only do I think that a person should accumulate 33x their annual expenses, but I think they should only live off of their residual income and never use any of the principal. What does this mean? It means never selling the stock or real estate that brings you the dividends and rent. Instead you only live off of the dividends, interest, and rent that comes from those assets. That way your income will increase along with the dividends, interest, and rent to help keep up with inflation, but you never have to dip into the principle. Thus not having to worry about the assets slowly dwindling away to nothing.
So now that all of that technical number shit is out of the way, what has actually happened to me over the past 3 full months of retirement? Well, according to the above scenarios, my net worth theoretically should have dropped by 0.75% to 0% since it's been 3 months. But strangely to my delight that didn't happen at all. The opposite happened! My net worth actually increased by 1.7% instead of going down. This is the benefit of living off of residual income instead of principal. By not digging into your assets, those assets are free to appreciate. Speaking of appreciation, this does not include any sort of real estate appreciation. In order to be conservative I always keep the purchase price of real estate at cost rather than speculate. Any sort of appreciation is only recognized when it's sold.
BUT WHAT ABOUT A STOCK MARKET CRASH??
Yes theoretically this should be a concern. In the above scenarios that 5% failure rate was usually associated with a falling stock market right after somebody retired, which I think will happen in the next 2-3 years. It's the worst time for it to happen, since you haven't been able to take advantage of any appreciation. However, this doesn't apply very much to me for a couple of reasons.
1. I have a years worth of cash set aside.
2. About half of my net worth is in stocks and half of that is in cash.
3. A majority of my passive income comes from real estate.
4. The majority of my net worth that is in stocks is in retirement accounts, so I currently don't receive any income from them and I won't be able to touch them for another 22 years.
If the stock market crashed by 50% tomorrow, my net worth would drop by 12% and it would have little to no impact on my income. If anything it would help it. How? If the market dropped by 50%, I could then use my cash to buy stocks on the cheap and get somewhere in the 3-4% range on dividends to further boost my income, rather than the current 2% (if you're lucky) that the stock market is yielding.
DURING RECESSIONS, INCOME IS STICKY, PRICES ARE NOT
But won't dividends, interest and rents fall during a recession? Yes they might depending upon how bad it is. To use the Great Recession as reference point, rent rates and dividends only fell by about 10%, even in hard hit areas like central Florida. That doesn't necessarily mean that income falls that much though. To help offset that, the government lowered property taxes and repairmen lowered prices to get any work that they could. So during the bad times income may fall by 7%, but that's a far cry from the price drop of the underlying assets to the tune of 50%.
WHAT CAN YOU DO?
I've been tracking my net worth since 2008 and on a monthly basis since the beginning of 2014. It's surprising how consistent it is month to month. Compiling and tracking your net worth on a monthly basis is one of the best things that you can do, along with tracking your monthly expenses. Once it's setup it only takes 5 minutes a month to update. Check out the link below to setup your own.