As former pension actuaries, we aren’t going to tell you how you should invest your retirement assets. Our Actuarial Budget Calculators (ABCs), however, can give you a pretty good idea of the value of assets you should currently have to cover your expected future essential expenses. This information can be useful in helping you decide how much risk you may want to take in your current investment strategy.
Inspiration for this post comes from the sage advice contained in two recent Forbes articles from Dirk Cotton entitled, “Negotiating the Fog of Retirement Uncertainty” and “Honey, What’s Our Retirement Plan?” In these articles, Dirk discusses how much of one’s retirement resources might be allocated to what Dirk refers to as “floor” and “upside” portfolios. According to Dirk, a floor portfolio is funded primarily by non-risky assets (i.e., Social Security, pensions, annuities and bonds) and is designed to provide a floor of safe lifetime income (or essential income), while the remaining assets (the “upside portfolio) is funded primarily by risky assets (i.e., equities) and is designed to fund future non-essential expenses.
Dirk states, “the most important decision you will make in retirement planning is how much of your resources to allocate to the upside and floor portfolios.” Dirk notes, “The correct balance [between floor and upside portfolios] will depend on how willing you are to risk losing your standard of living for the chance of having an even higher one.” His advice: “The less confident we are in our upside portfolio's ability to deliver on its promises, the more we should allocate to the safe floor portfolio. Finally, he concludes, “Many retirees and even some planners seem to be massively overconfident in upside-portfolio spending rules.”
What is the cost of $1 per year of real lifetime income?
Our ABCs can help you decide how much of your resources to allocate to these “floor” and “upside” portfolios. As discussed in the “Investment Strategy” section of our post of January 16, 2019, we suggest that you multiply the present value of future years with desired increases (and desired decrease upon first death for couples) by your estimated annual essential expenses to develop the value of your floor portfolio. This present value is located in cell M(18) of the Single Retiree ABC Input/Results tab and N(18) of the Couples Retiree ABC If you use our default assumptions, this number will be the approximate cost of purchasing an inflation-indexed life annuity of $1 per annum. You can then compare the value of your floor portfolio with the present value of your assets that are invested in less risky investments, such as Social Security, annuities, pensions, etc. to see how safely your floor portfolio is invested. The present values of your asset streams can be found in the PV Calcs tab of the ABC workbooks. The Budget by Expense Type Tab in the ABC for single retirees performs a similar calculation.
In our post of January 16, 2019, our hypothetical couple, Bill and Betty calculated the value of their floor portfolio as $1,109,295. In that example, They entered their ages and data into the ABC for retired couples and calculate a present value of future years (with desired increases and desired decrease upon first death) factor of 25.1520 in M(18) of their 2019 ABC workbook. Assuming their 2018 essential recurring spending remained at about $40,000 in real dollars each year, Betty calculated that the present value of the assets needed to cover their future essential recurring spending liabilities was about $1,006,080 (25.1520 x $40,000). To this amount, she added the present values of their essential non-recurring expenses of $103,215 ($57,722 for mortgage, $19,493 for extra healthcare costs and $26,000 for unexpected expenses) to obtain the total present value of their assets necessary to cover their total future essential expenses of $1,109,295 (the value of their floor portfolio). By comparison, the present value as of January 1, 2019 of their future income streams was $1,069,327, and less than $300,000 of their total present value of assets of $1,729,897 (about 17%) is invested in equities.
Conclusion
As indicated in our posts of January 16, 2019 and November 27, 2018, our ABC workbooks can provide information that you may find helpful in developing your investment strategy. We encourage you to use this information.
