How much money do you need to retire? If only there were a one line answer to this question! I see this discussed on a lot of blogs and news articles. In a recent post, I talked about the value of investing for equity growth vs strictly cash flow as a young investor. The goal with that is to grow a portfolio that will be large enough to accommodate the cash flow you hope to achieve in retirement.
How Much Monthly Cash Flow do you Need to Retire?
This is an easier number to divine, though is going to be different for every person’s situation. Ideally there will be social security in place, and potentially other sources of income at retirement. I think it’s safest to plan for the worst and take care of all of your financial needs and goals from your retirement portfolio. Let’s say for this example that you want $120,000 per year in order to feel secure in retirement. That translates to $10,000 per month.
Work Backwards to get your Equity Goal
Now we take our goal of $10,000 per month, (or whatever the number is you wish to make monthly in retirement) we can work back to look at what our target portfolio should look like. Look at what apartment buildings and other real estate assets return on their investments in your area. You’ll want to find the return on your investment, which essentially is going to be the net annual income divided by the purchase price. This is often called the “cap rate.” If the average cap rate in your area is 10%, then a typical $1,000,000 property owned free and clear should produce $100,000 per year, or $8,333 per month.
If you need $10,000 per month in retirement, and you feel like you can get a 10% cap on an investment property, you can calculate the size of property you’ll need like this: 10000 / .1 * 12 where $10000 is your cash flow, .1 is the 10% cap rate, and 12 months in a year. In this simplified example, you will need $1,200,000 worth of real estate in order to get $10,000 usable income per month.
Make your Plan to Work up that Equity!
So how do you get from where you are now to your goal? It would require a lot of properties to get to your goal if you’re just planning to get $100/month on each one. My suggestion is to take all of this into consideration while you’re investing along the way. What if you could get a property that is appreciating quickly? Or say you get a property that you can easily add a bedroom to or improve the rents, to force equity? That’s probably the best way to reach your goals. Find ways to accelerate your equity while you’re young, and prepare to sell off and reposition your equity for stable cash flow when you get to the point that you’re ready to live off of the income from your portfolio. Failure to see how this can happen, or to plan this out can leave hundreds of thousands of dollars on the table when you’re ready to retire.
Conclusion
This is a 100MPH drive by of a fairly complicated topic. Many investors develop this mindset over many years of looking at deals and planning for their future. All I’m trying to do here is plant a seed for understanding wealth management. If you start to take these ideas and follow what they mean to you and your portfolio, you can proceed in your investing career as well as your professional career with confidence that your future will be as secure as possible.
