Business is Personal (Finance)

In this thread at the Get Rich Slowly forum, a question was asked about everybody's expected rate of real (inflation-adjusted) return. My brain first started working on the answer like so:

• 6% stocks (5% overall, I overweight in risker equity allocations)
• 2% regular bonds
• 1.5% inflation protected bonds
  
• 1% commodities futures (insurance premium)
• 0% gold

With my target portfolio allocation:

• 60% stocks
• 20% regular bonds
• 10% inflation protected bonds
  
• 5% commodity futures
• 5% gold

This would calculate out to:

• 6 * 0.60 + 2 * 0.20 + 1.5 * 0.10 + 1 * 0.05 + 0 * 0.05 = 4.2%

Add in 0.25% for rebalancing bonus and I have an answer of 4.45%

But this got me thinking a bit. How much return do I actually need? After all, my parents are retired very comfortably on 0% real return on their portfolio. The vast majority of their investments was in rental income (they have yet to sell anything so no bubble inflated housing capital gains to artificially bump this number up) and CDs -- both of which peg the rate of inflation after taxes.

How did they do it? Well they came to the United States in their late 30's and early 40's. Once here, they studied English well enough to get white collar jobs -- however, these jobs never paid more than lower middle class wages. What they did have was typical immigrant frugal lifestyle. They saved 40% of their income without fail. Of course, this meant the life for us kids was very spartan. I don't recall any Christmas or Birthday presents -- I remember one year where we had cake and a party for a birthday. Eating out was reserved for Chinese New Year. Vacations? Are you kidding me?

But back to my parents ... let's go through the math on such a scenario. Since we are talking real returns, we can throw out inflation and stick with the same wage through the working career.

• Median household income: $50K
• Taxes: $5K (married couple w/ kids don't pay much at lower income levels)
• Spending: $25K
• Savings: $20K

So after 30 years of working, this theoretical couple would save up $600K in some combination of housing equity, rental property and cash. The math here is pretty simple -- divide total portfolio by annual expenses to get the number of years the money would last -- or 24 years in this case. Now let's say Social Security will still be around but paying less so this couple would draw $1250/mo in benefits. That reduces the annual "portfolio" withdrawal to $10K allowing the savings to last 60 years. Since it's unlikely to live until 120-130, they could increase their retirement spending by 40% (to $35K) and the nest-egg would still last 30 years.

As for myself, I may have gotten the best of both worlds. I emigrated to the United States very early in my life so I got all the opportunities but was able to build a base on my parents' money management habits. I make far more money than they did as I run a technology company but I also pay way more in taxes which makes it quite satisfying that I can exceed their savings rate.

Since I will probably be able to retire on 0% return given my extreme savings rate, why I don't I just stick with a lower volatility portfolio then? Unfortunately, my goals are different from my parents'. I have no idea whether I can pass on my money management skills to my offspring and knowing that the majority of inherited money is spent away after 2 or 3 generations, I have to shoot far higher. I either need to build up a portfolio in the tens of millions or build up businesses my kids can learn fiscal skills in (or hopefully do both).

For this reason, reading about my investing ideas is good but copying them might not since my goals are different from most people's. The entire range of real returns whether 0% or 5% will work out just fine for my personal retirement target. For this reason, my portfolio plan has an increased bond/commodity allocations with riskier equities to counterweight. The idea there is I will have the same expected return with a lower volatility. The side effect is the results set now includes the possibility of under-performing (and out-performing) a traditional portfolio. Under-performance would only affect the type of inheritance I would leave behind and at the moment, I still have conflicted philosophies on the strategy.

(Filed in investing)