Decisions, Decisions, Decisions

We, here at How Much Can I Afford to Spend in Retirement, advocate the use of basic actuarial and financial economics principles to help our users make better retirement-related financial decisions. We don’t claim to address every possible decision you may need to make before or after you retire. For example, we don’t address the tax ramifications of withdrawals from after-tax vs. pre-tax accounts (or any specific tax strategies for that matter) or how much you should spend on insurance products vs. self-insuring your risks.

Keeping It Simple

In our post of April 5, we encouraged you to develop a strategic plan for retirement that considers your spending goals, your tolerance for risk and your other preferences. We suggested that you could accomplish this task by using our Recommended Financial Planning Process, which we believe is a relatively simple and straightforward process. Of course, what may seem simple to one person may be complicated to another. While our recommended process does involve calculations of present values, our Actuarial Budget Calculator (ABC) workbooks perform these present value calculations for you, thereby significantly simplifying the process in our opinion.

Aligning Your Strategic Plan in Retirement with Your Spending Goals, Tolerance for Risk and Other Preferences

This post is a follow-up to our post of January 31, 2020—How to Develop and Implement a Strategic Plan for Your Retirement. In that post we encouraged our readers to assume responsibility for their own retirement by developing a strategic plan that aligns their spending and investment strategies with their retirement goals. In this post, we will encourage you to also consider your tolerance for risk and other preferences you may have, as recently suggested by two prominent retirement researchers. We will also discuss how you can accomplish this task relatively easily if you are using our Recommended Financial Planning Process. If you are not familiar with this process, you can find a description of it here.

Words Matter

Generally, our posts are written by Ken and are reviewed by Bobbie. This post is a bit different from our others in that it is co-written by both Ken and Bobbie, because she is very interested in being precise with terms. Since we often use terms that may not be familiar to our readers, Bobbie believes that we should define these terms so that all know what is meant by them.

What is Your Plan for Future Spending in Retirement?

The three key drivers involved in determining how your (or your household’s) assets will be spent in retirement generally are:

1. Your (or your household’s) future lifetime(s),
2. Your future investment returns, and
3. The pattern of your current and future spending

This post will focus on item 3. We will discuss recent research into actual observed spending patterns and possible implications for your financial plan.

Stress Testing Your Retirement Plan for Rising Interest Rates / Inflation

In our post of January 29, 2021, we suggested that you consider periodically stress-testing your retirement plan for unfavorable future investment experience by performing a 5-year spending budget projection assuming future assumed “crash-like” Equity returns. We included a 5-year projection example in that post for a couple who followed our Recommended Financial PlanningProcess.  The couple in that example experienced no decrease in their projected Essential Expense spending during the five-year projection period, but did experience fairly significant (but presumably manageable) decreases in their discretionary spending in the initial years of the five-year projection.

Life Annuities Can Be Worth More Than What You Pay for Them

At How Much You Can Afford to Spend, we encourage retirees (and retired couples) to adopt a Liability Driven Investment (LDI) strategy and consider building a Floor Portfolio of low-risk assets to fund their essential expenses.   Low-risk assets include lifetime income sources like Social Security, pensions and life annuities as well as other investments like cash and individual bonds.  In our post of February 2, 2021, we discussed how relatively easy it is to build your own Floor Portfolio.

Yes, “Probability-of-Success-Driven Guardrails” is a Good First Step

Kudos to Michael Kitces and Derek Tharp for attempting to fix some of the deficiencies in spending models typically used today by financial advisors, as previously discussed in our post of July 23, 2020. In their post of March 3, 2021, they highlight some of the problems with Strategic Withdrawal Plans (SWPs) and Monte Carlo models typically used today by financial advisors, and they propose incorporating the guardrail concept for determining annual withdrawals in SWPs advocated in the “Guyton-Klinger Rule” into Monte Carlo “Probability of Success” models to enable financial advisors to better advise their clients. And while we believe the resulting “Probability-of-Success-Driven Guardrails” (or Kitces/Tharp) approach is definitely an improvement over current practice, we remain unconvinced that it is superior to the Recommended Financial Planning Process advocated in this website.

Borrowing and Investing Proceeds in a Low-Interest Rate Environment

We’ve seen several articles recently suggesting that it might make financial sense to take out a home mortgage or car loan at current low interest rates and invest some or all of loan proceeds in equities or other risky investments. The expectation of such Leveraged Investing is that the higher expected returns from equities will more than cover the cost of the relatively cheap loan. The same issue also applies to households considering whether they should accelerate and pay-off their mortgages or car loans vs. investing those payments in risky investments. As an example of a recent article on this subject, the February 9, 2021 Squared Away blog from the Center on Retirement Research entitled, Readers See Pros, Cons to Paid-off Mortgage, contains the following quote:

Building Your Floor Portfolio

Sadly, our friend Dirk Cotton passed away on January 28 at age 68.  You can find many of his sage thoughts on retirement planning in his blog, The Retirement Cafe.  While we never met Dirk, we traded many emails and spoke on the phone frequently.  We were big fans of Dirk and his ideas.  If you search our website, you will find 15 of our previous posts that referenced his posts.