An honest answer is always: it depends. But of course, it would be hard to sell retirement planning services with that kind of answer, so the internet is filled with financial calculators and company written “articles” meant to make the process look as easy as possible. Then, once someone expresses an interest in “more information” the vast complexities are explained and the solution is, coincidentally, getting their sage advice. So, which is it, complex or simple? The answer is almost always simple, but with a big “if“ attached. Now, if you have many millions of dollars it can indeed be pretty complicated, depending on what you are trying to accomplish, but most people are concerned with getting the millions first. The big “if” is important and it is the reason that so many retirement planners are on the internet. If someone knows about investing and is familiar with the risks and rewards involves in each choice, then retirement planning cannot be any simpler. If someone has no idea about those things, then, yes it is complicated. For the purposes of this post I am talking to the former individual. If you are a somewhat knowledgeable investor, then it is probably best to ignore almost all of the “advice” being offered by the investment firms.
Let’s take an example to illustrate what I mean. Mr. Jones is 60 years old, has a house, fully paid for, $300,000 in savings from all sources (401K, IRA, savings accounts) and no pension. This is a fairly representative example and Mr. Jones choices are fairly easy. He can continue to work and try to save more or he can hope that his savings will cover him once he decides to retire. As a fairly astute investor, he has his money in a mixture of investments that should show upside as well as weather any storms. With an expected annual income from Social Security of $15,000, Mr. Jones feels he can pay his routine bills and taxes. Therefore he plans on using that $300,000 for all other expenses, such as entertainment and clothing as well as the big expenses such as cars and housing repairs.
Is it enough? That’s where the “it depends” portion comes in. Mr. Jones’ expenses are relatively light, but without a pension, his reliance on his savings could be worrisome. Not only can he not afford too many emergency expenses (new roof?) but he also cannot really withstand a stock market dive and so his portfolio will have to be so conservative that any significant growth will be nearly impossible. With no chance of much replenishment of his savings (at least in the current interest rate environment), Mr. Jones has to look at his savings almost like an annuity. If he retires now and lives to 90 he would have approximately $10,000 a year cushion above his regular living expenses. Not much is it?
Now, that is purposefully simplified and of course, the savings will probably grow at least a bit from interest alone, but it is also realistic. There is no reason to get in the weeds of what ifs. It’s always best to look at worst case scenarios and go from there. If Mr. Jones is indeed a veteran of investing, then he will almost assuredly work for a while longer and try to get that nest egg up through growth and/or additional savings. To make it even simpler, take a look at your savings and decide how much you would feel comfortable withdrawing every year. But remember, once the savings begin to dip, the amount withdrawn represents a larger and larger percentage of the portfolio. This can begin a spiral that is difficult to recover from. Once looked at from this angle, then retirement planning becomes easier and easier.
Most people feel very queasy about dipping into savings on a regular (and large) basis. Once looked at that way, most people suddenly begin to look at retirement in a much more cold and calculating way. And that is good. If one looked at their savings versus expenses (even in approximation) in a mathematical way, the path becomes clearer and clearer. In Mr. Jones’ case, I think most people would feel that he is not in an ideal situation to retire just yet. However, some would say that is plenty and a modest lifestyle is perfectly fine with them.
The bottom line is plan for the worst. Once looked at that way, the retirement decision can be greatly simplified. And it’s easy to scale into the more difficult investment related choices after that. Of course, many people are faced with very little choice in the matter (especially in this economy) but that is a topic for another day. I’ll be covering retirement planning all month, so I hope to get to your main area of interest soon. As always, if you have any specific topics that you would like covered let me know.