Dave:
Americans on average think they need $1.2 million to retire, which might seem reasonable at first, but there is a scary part here. Most people aren’t going to get anywhere close to that number. Over half of Americans expect to retire with less than $500,000 and many of them far less than that. But here’s the other thing that you need to pay attention to. Even though $1.2 million sounds like a lot, if you actually do the math, that may not buy the life you’d expect it to because almost no one accounts for the two things that quietly wreck a retirement plan, inflation and a social security system that may not be around when you go to retire, especially if you’re under 50. So today I want to talk about retirement and how to set a realistic retirement number and actually achieve it. And I have a simple framework I’m going to share with you that I personally use.
It’s designed specifically for real estate investors. And I’m going to walk you through how to figure out the number you actually need to retire, the real one, the inflation adjusted number. Then I’m going to show you why real estate investors get to use completely different and honestly better math to get to retirement than people who rely on equities. So if you want to secure your retirement using real estate, this episode is for you.
Hey everyone, welcome to On the Market. I’m Dave Meyer, chief investment officer at BiggerPockets and a lifelong real estate investor. Recently, I’ve been seeing a lot of worries about retirement. This is nothing new, but there have been a couple new retirement studies in the news and on social media. And honestly, they get me a little riled up because for how retirement obsessed we all are, myself included, the average American is kind of lost on their journey to retirement. Not only is the average American behind on their retirement, but many lack an understanding of how much they realistically need to retire. So not only are they behind on their goal, their actual goal is often wrong. I’ve seen some recent data that says that the average American thinks they need 1.2 million to retire. So another one said 1.4 million. Both of these sound like solid numbers until you do the math because 1.2 million using the 4% rule, which is a simple budgeting framework that says you could safely draw down 4% of your retirement account and not risk running out of money.
If you use that commonly used 4% rule, that only comes out to $48,000 a year. And that doesn’t sound like enough to me personally. I don’t know about you. Maybe for boomers who can safely count on social security, but I am sure as heck not counting on that social security that is. I don’t trust that and nor is $48,000 a year in today’s dollars enough to support my lifestyle. So today we’re going to go through retirement planning from a very simple mathematic perspective. I’m going to share with you the current state of retirement planning in the US and how well people are tracking against their goals. And I’ll explain why some of the traditional estimating tools that people use are really insufficient and they sell Americans short. But there’s good news. I’m going to share with you a better way to do it, a very dead simple framework that real estate investors specifically can use to plan their eventual retirement using real estate.
This is going to be fun. It’s going to be practical. I hope you take notes and actually go home and figure out these numbers for yourself because as we talk about all the time on the show, having a goal matters. And for most people, the retirement number, that’s the big goal. That’s the thing they really want to go after. So having this number correct and a plan to go after it is vitally important. Let’s do it. First up, let’s talk about expectations. There’s a new Schroeder’s US retirement survey and basically I told you this before, workers with a workplace plan like a 401k think they need $1.2 million to retire. Northwest Mutual did a similar survey. They came up with closer to 1.5 million. And we’re going to talk about whether these numbers make sense in the first place in a minute. But for now, you just need to know that regardless of the amount, the goal, people aren’t on track.
Even if they have realistic, maybe too low numbers in my mind, they’re not even on track for that. 51% of the people who participate in this survey expect to retire with less than $500,000. 24% expect less than 250,000. And although people have this idea in their mind that a million dollars is the goal to get to, only 30% of people will even get there. And so people have these numbers in their mind, but they know that they’re not on track to hit it. 81% of people are worried about outliving their money. 33%, this one kind of depressed me. 33% of people, a third of people have more credit card debt than they have in retirement savings. That is really rough. So yeah, it’s not looking good for the average American worker. And of course this is a big problem. Part of the social contract in the United States is that if you work hard and contribute, you should be able to retire at a reasonable age.
But for many Americans, that is feeling further and further away. And we should talk about why. There’s a lot to this question, but here’s the quick version. In the US, we now rely almost entirely on 401 s to retire people. Pensions have all but disapeared. Maybe if you work in the public sector, you still get that, but for most people, it’s about a 401k or an IRA because not everyone has access to 401k. And although this system has worked for some people and it can continue to work, it requires people to be diligent savers. Some people do that. Some people don’t due to bad financial habits, and some people legitimately just don’t earn enough money to put any money away for retirement. Now, of course, we have Social Security in this country and that’s supposed to provide the backstop to make sure people don’t run out of money, but the trust fund for Social Security is set to be depleted in 2032.
Don’t get me wrong, that does not mean Social Security will go away altogether, but it is at the point, unless something changes, that benefits will have to be cut. Pretty significant. I think I’ve seen up to 28% cuts just by 2032. I’m 39. So I’m looking 20, 25, 30 years down the line, don’t have high hopes here. I hope it gets fixed, but I haven’t heard a politician talk seriously about how they’re going to fix it in many, many years. And even so, the average retirement benefit on Social Security is only about $2,000 a month, so it’s never going to fund your retirement alone. So I’m not counting on Social Security. And although I do personally have a 401k, I do invest in the stock market. We have to address the reality that a 401k is entirely market dependent. If the market tanks in your first few retirement years or right before your retirement while you’re selling shares to live, you can permanently cripple your portfolio.
If you’re forced to sell low, that can really upset your entire retirement plan. That is sort of the fragility of living off of a pile of assets that you have to sell to live off of. So when you look at all these things together, the market dependency, the lack of savings, the uncertainty around social security, the traditional path is clearly not working. And not to make things sound worse, but I’m going to, I don’t even think those $1.2 million targets are enough in the first place, but people aren’t even on track for that. And I’ll explain why that target number is wrong because getting that target number right is so important, but almost everyone does it wrong and I’ll explain why and how to do it better after this quick break.
Welcome back to On the Market. Today we’re talking about retirement. We know now after the first segment today that we know people are behind and we know why the old playbook isn’t working the way we want it to. But before we talk about the framework real estate investors should use, which we’re going to get to, super easy. I think you’re all going to like it. I want to talk about your goal because this is super, super important because I’m just not buying that $1.2 million. When you’re doing retirement planning, most people use something called the 4% rule. It’s classic retirement math. It says that you can basically draw down 4% of your retirement portfolio each year and it will last for at least 30 years and you have a low risk of running out of money. So in other words, if you flip it around to become a target, basically you need 25 times the annual income that you need, right?
Because one divided by 4%, that’s 25. So it’s kind of like a 25% rule also. So when we bring this idea back to the $1.2 million target, if you use 4%, that throws off $48,000 a year before taxes. So you work for decades, you hit seven figures, you have a $1.2 million. It sounds like a lot. And the reward is below the median income in the United States. That doesn’t sound right to me. That personally would not support my lifestyle. And even if you add in the $24,000 a year from social security before taxes, 72,000 is decent. But personally, I would hope to have more. Not to mention the biggest thing this gets wrong and most people get wrong in retirement planning is inflation. This is a mistake I see people make all the time. People take their spending amount today. They multiply it by 25 using the 4% rule and they call that their number.
They assume their spending power stays frozen. But as we all know, it absolutely does not. Inflation eats the dollar every single year. The long run average is around 3%, meaning that in 30 years you need more than double, more than double the amount to maintain your spending power. In other words, in 30 years, your money will buy less than half of what it does today. So for example, if you say that you want the equivalent of $75,000 a year in today’s dollars, which is great, and you’re retiring in 30 years, if you multiply 75,000 by 25, you get about 1.9 million, which might feel doable. That might feel like a huge number to you, but either way it’s wrong because the real math is that that lifestyle, that $75,000 lifestyle is going to cost more like 150 or $175,000 a year due to inflation. And that’s at current inflation rates.
What if inflation gets worse? You can’t be planning around a number not accounting for inflation. So just to live a $75,000 lifestyle, you need closer to four and a half million dollars, not $1.9 million. That’s more than double. And that gap right there is why so many people retire and then feel poor. But real estate investors, we get to do it a little different. We actually get to use different math, better math in my opinion. And I want to share it with you because I think it’s a better, probably easier path. The 4% rule assumes you’re living off a pile of stocks and equities, maybe some bonds that you slowly sell down. But in real estate, we don’t do that. We live off what our equity produces. Our assets keep working in the form of cashflow. We’re not selling properties and then living off the proceeds.
We are keeping our money invested and it has a cash return that we can live off of. So instead of a 4% safe withdrawal rate on an equities portfolio, we need to use a different number. We need to use return on equity. You may have heard me talk about this on the show before. If you’re curious about it, you can look it up. I’ve written all about in my book, Real Estate by the Numbers. Return on equity is basically a measure of how efficiently your real estate is earning money on the equity you have invested. And that comes in the form of cashflow, yes, but it also can come in the form of appreciation or amortization or tax benefits. And a well-won real estate portfolio should produce a return on equity at least eight to 10% over time. Most of my properties produce 10 to 20%.
Sometimes if you hit a home run, it can be higher than 20%. So saying eight to 10% on average I think is good. And we’re talking about 20, 30 years down the line, don’t know what’s going to happen. So I don’t want to use some ambitious number. And as you get closer to retirement, you may choose to have a lower ROE because it’s a lower risk investment. That makes sense to me. Maybe you don’t use any leverage you buy for cash, which is great, that increases your cashflow, reduces your amortization. So eight to 10% I think makes sense, but I’m just going to be even more conservative because not all return on equity is spendable cash in hand. And so instead, let’s use 6% because we could just say that’s even our cash on cash return. The other stuff is just equity. It keeps growing your equity.
6% ROE though in terms of your cash return, no problem. You go out and buy almost anything for cash and it will probably return five, six, 8% cash on cash return. So we’re going to be very conservative here and use 6%. So this return on equity is one important number. The second number is your total equity, how much equity you actually need invested at that 6% return on equity to hit your income goal. So it’s the same idea as the 4% rule, but it’s just a better yield. Instead of 4%, I think real estate investors can very conservatively use a 6% return and that actually makes a huge difference. If we go back to our example of a $75,000 lifestyle, which we adjusted up to about $175,000, remember with equities at the 4% rule, you needed over four and a half million dollars. But with real estate at a 6% ROE, that number goes from four and a half million to three million.
That’s a big, big difference. If you’re able to achieve an 8% ROE, that gets you to 2.3 million. That’s about half of what you need if you’re investing in the stock market. This is a huge difference because our equity works harder and more reliably and because we live off whatever produces, what our equity produces instead of selling it, we need less equity to retire on the same income. And as you know, it just compounds in our favor, right? Rents rise with inflation. Our fixed rate debt gets cheaper in real inflation adjusted terms. Tenants pay down the loan. The real estate portfolio is an inflation hedge built in the exact thing that wrecks a lot of stock-only plans. Now I’m not saying stocks don’t adjust for inflation. They do in many cases, but real estate also doesn’t have that market risk. Now in a worst case scenario, even if the housing market crashed right before your retirement, rents almost never decline in the same way.
So even if your equity value goes down, you will still be generating the same income so you can still live off it even if the market tanks and you have really bad timing with your retirement. This is why real estate investing is so good for retirement. The math just proves it. So then how should real estate investors be planning for their retirement? I have a very simple aproach to this. I use it for my own planning and I’m going to share it with you right after this quick break. Stick with us.
Welcome back to On the Market. I’m Dave Meyer. Today we’re talking about retirement. Before the break, I share with you why the traditional 4% rule makes it harder than real estate investors have it. We have it a little bit easier because we don’t sell our assets. We live off the cash that they create. And so for real estate investors, we do retirement planning a little bit different. And I’ve just kind of come up with this framework myself, but I’ve talked to many other investors one-on-one, just giving advice to people and shared with them these just two simple numbers. It’s so easy. And I see this light bulb go off for people and they’re like, “Oh my God, I get it. I know what my goal is. I know what I have to do. ” Everything becomes easier when you know these two simple numbers. I’ve already explained them to you.
Number one is your return on equity. And number two is your total equity. How much equity you have in your properties. Figuring out equity is pretty easy. It’s basically your assets minus your liability. So the simple way to think about this is if you took your portfolio and sold it all, paid off your loans, paid all the fees, what would you walk away with? That’s your total equity. So those are the two things you need to know, your return on equity and your total equity. Hopefully this makes sense. If you know your total equity and your return on equity, you can figure out how much income you’re going to be having right now. So how should real estate investors figure out their number? And I’ll talk about how to get to that number in just a second, but how should you figure out your number?
Your real number, inflation adjusted number? Figure out your annual spending in today’s dollars. What do you want? And then adjust it for inflation. A good rule of thumb is just double it. So if you want to live a $100,000 lifestyle in your retirement 30 years from now, double it. You’re going to need $200,000. Don’t skip that step. It’s the one everyone gets wrong. Don’t skip it. Second, just convert it to an equity target. Take that annual income that you want and divide it by your return on equity. I’m going to recommend using 6% to be very conservative. So if you take that inflation adjusted number, so it’s $200,000 in our example, and you divide it by 0.06 or 6% return on equity, that would mean $3.3 million. That’s your equity target. That’s what you should be shooting for. That’s the number that matters. And I know that’s a big number.
I’m not saying retirement is going to be easy just because you’re a real estate investor. It still takes a lot of work. But now at least you know the number that you need to live a good lifestyle, right? 100 grand lifestyle in 30 years, that’s great. $3.3 million is what you’re going to need through real estate, in equity value, in real estate. That’s what you need. And once you have this number, I think something about your portfolio planning and your decision-making about real estate becomes so easy and clear. Building the equity, that $3.3 million is the hard part. The cashflow is not important right now because you’re not going to build up to that $200,000 a year, 200 bucks per month at a time. What you need to do is focus on the equity now because the cashflow is easy. It really is. I know cashflow is hard to find right now, but hear me out.
Building a big pile of equity, $3.3 million, saving up for down payments, forcing appreciation, doing value add, waiting for real gains and market appreciation, paying down loans, reinvesting every dollar. That’s the hard part. It takes time. It takes patience. That is the mountain you have to climb. But once you have that equity, converting it into safe, low risk cashflow, that’s easy. That is super easy. If you have all that money, pay off your mortgages.Do a 1031 into a higher yield cashflow. Move from growth markets into income markets. It’s super easy once you have the equity. Focusing on cashflow once you have the equity, that is a lever that you pull at the end when you’re close, when you’re ready to retirement, when you’re ready to move from growth mode to harvest mode. And this is why, and I know a lot of people will argue about this, it’s why I think most investors focus too much on cashflow too early.
Chasing 150 bucks a month of cashflow on a cheap rental in your 20s or 30s or 40s, it doesn’t move the needle. And those properties often don’t build equity at the same rate. So you’re optimizing for the easy number and ignoring the hard one. And I am not saying don’t buy cash flowing assets. I only buy cashflowing assets. If you’re holding onto something, it should cashflow once it’s stabilized. It doesn’t need to cash flow from day one. But once you do renovations, you stabilize it, it should cash flow. Not because I’m going to retire on those numbers, but because it removes a lot of risk for the equation. It allows me to keep building and to stay in the game over the long run. So in my opinion, in your early career, once you know these numbers and you see that that equity number, that’s what you need to focus on to get your cashflow later.
Early in your career, you need to be maximizing your total return in equity growth. Be willing to trade cashflow for appreciation and forced equity in the short run. Again, buy cashflowing assets if you’re holding onto them, but it’s always a spectrum, right? Certain deals are going to have more cashflow, less appreciation, les ability to force equity. If it’s me and what I’ve done and what I recommend is early in your career, focus on that equity number. Then late in your career as you near your retirement age, you flip the switch, you convert that equity mountain that you have built into the income you actually retire on. This reframing, this idea changed how I invest. And I think it does for a lot of people. When I talk to people and go through their portfolios with them, this idea really, really changes their way of thinking and I think it will for you.
So again, what I recommend you do after you listen to this episode is go figure this out, find your real number. Again, they’ll just go through the formula again. Desired annual spending in today’s dollars and then double it. Divide it by a conservative ROE of 6%, get your equity number and then build backwards. How do you get to that number? Because a lot of people have this light bulb go off. Maybe they own six, seven, eight great rental properties that are producing a little bit of cashflow, but their total equity is $800,000. So holding onto those eight rental properties and not trading, that’s a long way to go to 3.3 million if that’s your number. And so people realize I need to either refinance, I need to take out a HELOC, I need to tap that equity to keep building. I don’t care if that reduces my cashflow from $300 a month to $100 a month because the equity growth is what I care about.
That’s the real path to retirement. That’s what I’m doing. And it’s one that you can actually control. So go out, figure this out for yourself and start orienting your portfolio around your long-term goal. That’s something all of us can do. And thankfully, real estate makes this so achievable. There are so many great ways to build equity and then you get the cash flow later. To me, this is the most reliable, predictable way to pursue retirement in the United States. And it’s one I think all of us in the on the market community can be working towards. And who knows? Maybe you’ll even get a little social security to be the icing on your cake. Let’s hope. But if not, you will still be prepared and that’s what I want for all of you. That’s our show for today. Thank you so much for watching this episode of On the Market.
I’m Dave Meyer and I’ll see you next time.
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