Imagine a forty-year retirement. That’s a lot of golf and travel and the ‘honey do’ list at home may actually get finished by then. But really, what would you do if this happens to you? Your retirement planning needs to begin now.
Your retirement planning for the long haul begins with a look at your risk of living and balancing that with a proper portfolio withdrawal strategy to support your retirement lifestyle. It’s one thing to spend your life building your retirement nest egg. But it’s entirely different to consider how you actually plan on distributing that money to create a retirement pay check. Complicating this discussion is the potential for living longer in retirement than your entire working career.
Start with Life Expectancy
When I work with a client of any age, I start with assessing the probability of a long-lived retirement by asking questions about family longevity and medical history. Armed with this as well as answers to a number of health questions, I use different tools to come up with a more personalized estimate and probability of longevity than simply using the table available from Social Security.
Generally, given the advances made in medicine to date and knowing that we humans are good at finding new technologies, we can assume that there is a high probability of living longer than what the current insurance actuary tables may say.
Once I come up with a life expectancy, I build this into my planning horizon. After all, it’s not a matter of ‘if’ you’ll die but ‘when.’
Stress-Test Your Plan and Chart Progress in Retirement
Using a projection of retirement lifestyle expenses and income sources, I use planning software that projects whether a client is on target (‘in the green’ so to speak) or off course (‘in the red zone’). Coupling this with some high-powered math like Monte Carlo simulations to create a number of what-if scenarios, provides me with a number of reports that visually show how a client’s retirement lifestyle will be impacted by changing tax rates, inflation, spending patterns and investment returns.
Clients and I use this plan as a personal benchmarking tool to check progress along the way. Forget about the S&P 500, what matters is whether or not your spending, savings and investing strategy works for you.
The Bucket Brigade: Build Your Retirement Pay Check
Once we have the base line in place, we can work on creating a personal retirement pay check.
I prefer to use a modified bucket strategy approach. This is a helpful mental accounting approach to how your nest egg resources are allocated. Each bucket is targeted for a different time frame ranging from the immediate (0 – 3 months) out to 10+ years.
The number of buckets may differ from client to client but generally follows a consistent pattern.
Bucket 1 is for household operations (so 1 -2 months of expenses) held in the checking account. Bucket 2 is for the Working Capital Reserve (or whatever name you choose) that covers from 1 to 3 years (avg 2) of fixed expenses held in near-cash (including ultra short-term bonds). This bucket is used to cover shortfalls to supplement retirement lifestyle needs and acts as a buffer. When the market has a correction during your retirement (which will inevitably happen) you can draw on this bucket without having to sell your longer-term investments in a market downturn.
Two other buckets are added with progressively higher equity exposure and risk. Why? To counter the insidious impact of inflation, equities provide the best alternative.
Given the longer life expectancies, Dr. Wade Pfau’s research has indicated going with higher equity exposures for longer time periods in retirement will help sustain a retirement nest egg.
Once retirement begins I then calculate a sustainable withdrawal strategy. The withdrawal strategy starts with an initial base amount to fill the gap in lifestyle spending needs above and beyond other income sources (work in retirement, pension – if fortunate, SSI, rental income).
Then the annual withdrawal rate is adjusted annually based on the portfolio’s market performance for the previous year. Sometimes a client would get a ‘raise’ and other times not. In the latter case, they can use the Working Capital Reserve to supplement until presumably the market rebounded.
The approach can be modified to include some type of guaranteed income – maybe an appropriate annuity like a longevity annuity. But I haven’t had to deal with that yet.
This approach is certainly easier to manage when I have direct control over the accounts. But sometimes there are clients who choose to handle some of these buckets. Best I can do is review it and make recommendations at subsequent annual meetings.
To mitigate the risks of loss in the portfolio, each client has the Working Capital Reserve and investments in a portfolio mixed between more conventional Strategic Asset Allocation based on Modern Portfolio Theory and tactical investment approaches.
This is a work in progress and tailored to each client. Your thoughts? I’m open to improvement.
For more on retirement planning for a 40-year retirement, check this out: http://findependencehub.com/rising-life-expectancy-are-you-ready-for-a-40-year-retirement/