Rule #1 Finance Blog

With Investor Phil Town

The Benefits of Compound Interest After Retirement

When you are ready to retire, how much of your stock should you sell?

Let’s pretend it’s time to retire and we have $1 million of stock invested in a wonderful company…

Not too bad, huh?

We can sell all of our stock in the company and use that to finish paying off our mortgages, travel the world, and visit our children – or we can keep our money in the company and skim what we need from the top to live during retirement.

Which path to retirement is better?

Scenario #1: Sell All of Your Stock

When we sell the stock, we’ll pay long-term gains tax on the million and end up with roughly $850,000. Then I suppose we might invest in a government bond at 3% and we’ll have $30,000 per year after tax to live on.

This is how someone not tuned into Rule #1 would retire.

And since we play by Rule #1, we know we can invest our retirement money without fearing loss, so why would we sell 100% of our company as long as it continues to be a wonderful business?

Why not keep the million dollars growing at 15% and live on the annual gains?

Where else can you get 15% or more returns on your money? Certainly not in a government bond.

Obviously, this assumes Mr. Market is rational, which, as we know, he isn’t all the time. In the real market in any given year, the price of your stock could be far above or below the 15% increase we expect.

For a retiree, those ups and downs could create an emotional rollercoaster, especially during a stock market drop. For now, however, let’s assume Mr. Market does get it right enough for this example to be true on average.

Scenario #2: Sell Only the Stock You Need for Living (Keep the Rest Invested and Compounding)

At the beginning of that year, we had $1 million of stock and it continued to grow at 15%. This means that by the end of the year, we have $1.15 million of stock.

If we sell just those gains from that year, or $150,000 worth of stock, and pay long-term gains tax of 15%, we have $128,000 after tax to live on.

Two scenarios set up with the same amount of money, yet two entirely different outcomes. With the exact same amount of retirement money at the start ($1 million in stock), a Rule #1 investor is living on $10,000 a month while another millionaire (who cashed out of the market and bought a bond) is trying to get by on $2,500 a month.

This little compounding interest example highlights one of the great and wonderful benefits of Rule #1 investing:

After a few years, our wonderful Rule #1 business is compounding all of our money— including our gains—over the years at such a rate that, even starting with a small amount of capital, we’ll be able to live very well off our investments in a very short time.

Can you imagine just sitting there retired and watching a $10,000 investment you made 20 years ago handing you $150,000 per year with zero work on your part?

Nirvana in retirement.

Are you unsure of how much you need in retirement, or how much you need to save? Use this free early retirement calculator to calculate exactly how much you need to retire comfortably.

 

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Phil Town is an investment advisor, hedge fund manager, 3x NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.

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