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.

How Effective is Your Financial Advisor’s Monte Carlo Analysis as a Retirement Planning Tool?

Thanks to Mark Chamberlain, Co-Founder of The Open Architecture 2020 Group, for pointing us to an interesting Retirement Management Journal paper by James B. Sandidge entitled, “Odds Are Retirees Don’t Care about the Odds.” Mr. Sandidge’s well-expressed reservations about Monte Carlo Analyses typically used by Financial Advisors struck a chord with us as we have expressed our own misgivings in many of our prior posts. In fact, in our most recent post of January 10, 2021, we said,

How Conservative is Your Financial Advisor’s Calculated Spending Budget?

It always fun for us to review budget calculations done by others. In this post we will review example calculations done for Hank and Marie in Michael Kitces’ and Derek Tharp’s January 6 post, Why 50% Probability Of Success Is Actually A Viable Monte Carlo Retirement Projection. We briefly discuss Hank and Marie’s data below, the assumptions we made and compare results using our Actuarial Budget Calculator (ABC) with results from the Kitces’ Monte Carlo model to gauge how conservative their model results are. In summary, their model is less conservative (more aggressive) than the ABC with default assumptions, in that it produces higher initial total spending budgets. 

Time to Perform Your January 1, 2021 Actuarial Valuation

Congratulations.  You made it through 2020!  

In our ongoing effort to turn you all into actuaries, this post will recommend that you perform an “actuarial valuation” based on your personal data as of January 1, 2021.  As part of this process, we will also encourage you to  prepare an “actuarial report” to document your thought-process and any planning decisions you make for this year.