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.

 

Early-Retirement-Calculator-Internal-Blog-Banner

 

 

identicon

Phil Town is an investment advisor, hedge fund manager, two-time 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.

  • Bart Sullivan

    Phil –
    Sounds good. Question, why do we use the term compound interest when the market does not actually compound, but provides a rate of return? For example, except for dividends that may be reinvested, the market actually gives us a return which is the difference from the price we bought versus the price when we sell. True compounding would mean that we earn a percentage on our previous growth amount.

  • Andrew Rush

    an annuity or a well designed IUL will have tax free growth. Pay the capital gain and then never pay taxes again. To assume 15% ROI each year is horrible advice and misleading. Any broker exceeding 7.5% should not be taken seriously

    • Ryan Chudyk

      Hey Andrew,
      What do you like about an IUL? From what I’ve read, the only way to make money on them is by selling them and collecting the fees.

      I’m just not sure there Is such a thing as a well designed IUL. There is a lot of fine print in those documents and should be read extremely carefully before pursuing that style of speculation.

      My understanding of them is that they will only return around 5% on average. It would be better to just buy a low cost ETF if you didn’t want to do any investing on your own, or follow the Couch Potato style of investing.

      15% is a good goal to reach for if your investing for yourself. You don’t have to pay management fees and you don’t have the time restraints that they do. This is what allows us to beat the ‘big guy’s’, it’s our competitive advantage. Or at least one of them.

      Don’t get me wrong, achieving that 15% will take work, and some knowledge which comes from putting in the work. But, the work you put in can directly correlate to the returns you achieve.

      • Andrew Rush

        Ryan I do not know what you do for living or how you invest your retirement income but generally so sorta of a fee will be paid. you pay fees on your 401k, ROTH IRA, etc.

        As for IUL, who ever tells you 5% or research your doing you need to do more. Like any insurance product, the return will be based on how well the company is providing the product. I writems products only using A rated or better companies. My E&O insurance will not provide coverage on a Babcock rated company and I am independent.

        Midland National has the best IUL product and one of the lowest pay out to brokers so the client can get more and better benefits. Better the product lower the commission. I want happy client, I do not look for the bigger commission.

        IUL if designed right like mine is based solely off the S&P500. 2015 was a down year but rare for the S&P500. The maximum return is 14.5% a year on an IUL. However it is designed to take advantage of the upside and never downside of the market. So 2015-2016 year is most likely not paying any return but also no lose. You have a 5 year guarantee 3% . If the S&P is over 14.5% then you get the maximum that year allowed. Historically the S&P500 avg about 8% over last 5,10,15,20 years. very solid and conservative index.
        an IUL using the lost decade with 100k would have 212k after 10 years without fees where a regular money market using S&P return and loses would have 102k . Major difference when no downside just zero return. you need to sell the product right and structure it right which is what I do. plus the built in for free into the product are top notch.

        • Ryan Chudyk

          Hey Andrew,
          Thanks for responding!

          The two accounts I have currently are a margin account, and a TFSA (tax free savings account) which is the Canadian equivalent to a Roth IRA. The only fees I pay are transactional (buying, selling stock and options) and a very small monthly fee.

          I confess I don’t have a great deal of knowledge when it comes to IUL’s. Thanks for taking the time to explain them a bit better. They do sound interesting. How is it that they can afford to not have any downside? Aren’t they just investing in the market with that money? Sorry I’m not exactly sure how that works from a business side of things.

          My other question, if you don’t mind me asking, is what risks the purchaser of an IUL has if the company that sold them the IUL goes bankrupt?

          This is a new avenue of investing for me that I’m not very familiar with, but I’m honestly fascinated by it.
          Maybe intrigued would be a better word…

          I applaud you for putting the clients needs above your own. I think that may be rare in your line of work.

          Just to see if I have this correct, if the S&P returned 14% those year, the owner of one of your IUL’s would get 14% as well? Or how much do fees cut into that?
          Also, that guaranteed 3%, is that per year for 5 years or 3% after five years?

          What are the ‘built in for free’ products you mention at the bottom?

          Again, thanks for helping me to understand this better.

          ~Ryan Chudyk~

          • Andrew Rush

            I am not familiar with the insurance policies in Canada and not sure if you can even purchase an IUL. Actually NY is the only state in US you can not purchase an IUL however if you move to NY afterwards ita okay to keep.

            first thing is insurance companies never really go out of business. if it does by law all other insurance companies have to buy theor policies and keep them in force how they were originally structured which is why insurance is always a solid investment to supplement retirement income plus it grows and is disbursed tax free in the US.

            as far the gains and losses. Honestly insurance companies know how to invest their money. Typical they control $10000 or more per $1 in the market . I trade forex and futures and I trade at $1000 to $1 ratio and never risk more than 3% of my brokerage account balance in the market. So a $20000 account, I invest $600 but leverage it to $6000 in trade values. make 2% and I make $300 for the day.

            all IUL are different. some companies have max of 7 or 8%. they have crappies products, pay higher commissions and more fees I say plus are not A rated.

            the insurance companies are banking a stringredients S&P500 but some use other indexes but they are to violate to really be used.

            Midland is one of the few that add in longterm disability for free. If you need to move into a retirement home at anytime, your policy will start withdrawing policy amount till it is gone. people pay $5000 a year for those policies. this is free. you can add other features for low cost but generally you do not need to add anything else and I do not discuss them unless brought up
            no point

            look up the S&P 500 returns over last 20 years. It is great really. if you make 8%or more you be happy tax free. the fees are nominal like any policy. typically the 1st 2 years there is no cash value as it builds. the fees are around 1% a year but get capped on longterm growth much less than a 401k or Roth IRA.where your fee is based on balance. imagine 1% of 200k account and negative return, it sucks.

            goto midland national website and do some reading.

          • HYoung Young

            I went to Google and found that people are having a difficult time getting their money. One woman had paid since she was 17 years old and thought she had a retirement account. Now, she has to take legal action…….

          • Andrew Rush

            I doubt she has an IUL since the product is less than,15 years old. Also insurance has what’s called accumulated cash value which is different. Your cash has to grow and you get a yearly statement. Anyone can cash a policy out upto it’s accumulated cash value. there is paperwork to fill out and if dealing with a A rated company it is very quick. no ins Co I know of will hold money hostages. generally you have your broker handle all paperwork.I say the Google review is bogus or someone does not understand something. typically it takes up to 1 week to get funds.

            what product does she have?? what is she doing with the product to request funds? loan or cashout?