Adventures in Retirement Planning

Published On: December 8, 2017

Written by: Ben Atwater and Matt Malick

Preparing for retirement is a more difficult goal than people imagine.  Working with clients on detailed retirement plans over the last nine years, we have approached planning using two different tools.  During the last three months, as we’ve transitioned from one program to another, we’ve gained additional insights into the planning process.

Quite reassuringly, despite the different software programs, we have found similar results for clients who have been through both processes.  In each process, we employ Monte Carlo analysis where we rely on repeated random samplings of historical investment returns tested against cash flows to determine a probability of success (i.e. in what percentage of the random scenarios do you have money left to pass onto heirs?).

Each program, however, draws its returns from different time periods, uses different rates of inflation and includes different asset classes.  Nonetheless, the results are similar.  We are encouraged that approaching the planning differently still generates similar results.  Anecdotally, we think it helps validate our planning process in general.

Although the results are similar, the new process is more dynamic and thought-provoking.  We spend additional time with clients thinking about expectations and concerns, which, directly and indirectly, better frame the discussion.  This is particularly the case when it comes to estimating spending in retirement.  Making an assessment of your priorities, values, goals, lifestyle, desires, etc. allows you to make more realistic projections for what you’d like to spend in retirement.

Spending in retirement is still the greatest challenge in creating a realistic plan.  We find that people generally underestimate what they spend now and fail to think about some of the expenses that retirement brings.  Categorizing spending more specifically, in areas like healthcare, cars, travel, home improvements, weddings, a new home, gifts and donations, etc. and dividing these between needs, wants and desires can help make decision-making easier.  Generally speaking, even for the mass affluent, retirement goals are a tradeoff, sacrificing one ambition to enhance another.

Exploring various options like early retirement, spending levels, investment risk, additional savings, when to take Social Security, etc. sheds light on determining the right plan for you.  There are so many moving parts that being able to quantify changes in each is invaluable.

We are excited about delving deeper into retirement planning.  Not only do we have some excellent tools, but we have a great deal of experience and good intuition for providing ideas and answers.  For now, here are a few general retirement planning observations that we’ve considered in recent weeks:

• Don’t underestimate the destructive power of inflation.  To use an extreme example, a nursing home that today costs $150,000 per year will in 25 years, using historic medical inflation of 6.50%, cost $724,000.  A less dramatic example, an $85,000 pension today will in ten years have the buying power of $63,247 in today’s money, assuming 3% inflation; that’s a big pay cut.  Because of inflation, prudent investing is an absolute necessity.

 

• Retirement plans don’t work if one bails on the market during bad times.  You need to be able to withstand the volatility of markets in order to succeed.  It is best to know your risk tolerance before the market falls.  A portfolio invested in 70% stocks and 30% bonds lost about 31% during the Financial Crisis (November 2007 through February 2009).  If you had a $2 million portfolio, it fell by $620,000.  The worst decision you could have made was to sell.  Be comfortable with the risk you are taking and stick with it through thick and thin.

 

• The earlier you begin detailed retirement planning, the more opportunity you have to make adjustments.  Subtle changes early on will make a big difference.  The biggest mistake that people continue to make is underestimating their retirement time horizon.  With any luck, retirement will last a very long time.  Be prepared.

 

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