Your Money Your Values
Once retired, the planning doesn’t end. You’ll still want to remodel, travel, or perhaps move to a different state. A plan helps outline the financial aspects of these decisions.
Take the case of a couple we’ll call George and Marla. They began working with us in early 2007. George is ten years older than Marla, and the goal was to get Marla retired so they could have time together while both are still healthy and living an active lifestyle.
Marla retired in 2010 and the two began traveling. In their first year of retirement they fell in love with Ouray, Colorado. They considered either buying a second home or moving there. We ran the numbers and suggested they spend more time there vacationing or renting before making a final decision.
By thinking through it, they decided they didn’t want to make a move, or have the hassle and upkeep of maintaining a second home. Instead they wanted to maintain their current home and travel more.
And travel they have! Their recent description of their trip overseas, filled with natural hot springs and outdoor ruggedness, made me want to travel more. They are definitely enjoying retirement and they understand the value of ongoing planning. That’s why at the beginning of this year they came in with the question, “How much can we spend this year?”
We decided to surprise them and ran their plan as if they spent an additional $50,000 a year, each year for the next ten years. No, that isn’t a typo. Not $5,000 a year – $50,000 a year. And their plan looked just fine. (They have over $1.5M in financial assets, as well as a pension and Social Security, and there mortgage is paid off.)
We call this the “spend more now” plan. We assume a 5% growth rate on investments and a 3% annual increase in base living expenses now through life expectancy. We then test the plan in three ways:
- Probability testing based on random future returns
- Probability testing based on historical returns
- Safety first testing based on a required return
Let’s take a brief look at how each one of these tests works.
1. Probability testing based on random future returns
You might retire into the greatest 20 years of market returns ever. Or you could retire into the worst 20 years. If the latter occurs, even though you make all the right decisions, you will end up with far less income or assets then if the former occurs.
Probability testing uses something called a Monte Carlo analysis and projects your asset values through life by running numerous simulations using different return possibilities. This testing includes accounting for the withdrawals you will need to take.
2. Probability testing based on historical returns
Using a particular strategy called liability-driven investing, we can ladder safe investments (like CDs and government bonds) so they mature in the years you need to take withdrawals. Let’s say we secure the first 8 years of your retirement income; then the remainder of your portfolio is invested in growth.
This is often referred to as a time-segmented approach. This strategy can be tested based on historical equity returns(including the Great Depression) and based on historical yield curves. If your probability of success is high, we know you’re in good shape.
3. Safety first testing based on required return
We also look at the specific cash flows you will need and can determine the minimum return you need to achieve your spending goals. If your required return is 4% or less, you’re in pretty good shape. If you need a return of 5% or more to meet your goals, you fall in the constrained or underfunded category.
If your plan looks solid, meaning it has close to a 100% probability of success and a required return of 4% or less, we feel confident that it will work. That’s when we get the fun job of telling someone they can spend more now.
If your plan looks good, and has a probability of success of 85%-100%, or requires a 5% or higher return, we tell you that your ‘spend more now’ plan might work – but we caution you that if the markets deliver poor returns for a sustainable number of years, your plan will need to be adjusted downward, and you may need to make reductions in spending.
If your plan has a lower probability of success, we caution you against spending more now, and discuss other options that may help you achieve your goals. We may also look at what is needed to get your plan back into solid shape.
This type of scenario modeling helps most upcoming retirees do one of two things:
- Enjoy more fun things now, without any nagging worry in the back of your mind, or
- Know what changes need to be made to get your plan to a place where it looks solid.
For those of you haven’t done any planning yet, we’d ask you, why guess, when you can know?
We’d welcome the opportunity to take you through our planning process. To inquire about our services we ask that you fill out our Pre-Meeting Questions. Once we receive those we reach out to schedule a complimentary introductory meeting to learn more about you and explain our pricing options.