Financial Planning for a Long Retirement
How should individual investors ensure they have enough money for retirement?
Such a person is often a professional or entrepreneur who has worked to accumulate the wealth. Legions of "advisors"line up to take this money and manage it or else to sell "products" that promise to solve some problem or other. Without this background, extra savings will be needed, to buy advice. And advice is not invariably reliable.
A person who has created his/her career and its wealth from scratch, can likely manage investments themselves, or at least supervise the process from a position of strength from observation. Reliable advice is not always cheap.
This collection of articles explains to the individual investor how to take control of their wealth. They may eventually decide to look for help from an advisor but they will retain control of their assets and they will know what to do.
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Right Angle Club: 2013
Reflections about the 91st year of the Club's existence. Delivered for the annual President's dinner at The Philadelphia Club, January 17, 2014. George Ross Fisher, scribe.
There is scarcely any need to list the uncertainties of planning for retirement. To make a precise number, you would have to know how long you expect to live, how much you need to spend, how much cash flow is assured, how much your stock portfolio will be worth, what the rate of inflation will be, and so forth, and so forth. When you get done listing all the things you have to know, the general tendency is to assume the task is impossible. It's hard, but it isn't impossible if you know a single number: the average growth rate you need to achieve, if you are going to be in exactly the same financial position on your 100th birthday, as you are today. In my own case, the answer is 1.5%. I have arranged my own affairs in such a way that if my stock portfolio maintains a 1.5% growth rate until I reach my 100th birthday, it should be worth the same as it is today, on that happy occasion in the future. So, having the magic number of 1.5%, let's work with it. By the way, that's net, net -- net of inflation , net of taxes.
Inflation is supposed to be targeted by the Federal Reserve at 2% per year. It wouldn't be wise to count on that, but taken at face value, I can still break even if the nominal portfolio growth rate averages 3.5%, a conservative figure net of taxes. Remember however, you have to pay taxes on any taxable investment expenses. If you sell appreciated stock to have cash for portfolio re-balancing, you probably must pay capital gains taxes, if you take a lot of dividend income you will have to pay standard income taxes on it, if you get a new investment advisor who charges a lot you will probably have to pay him extra for his alleged expertise. In other words, if you get careless in your investment choices, you could find it will require an increased average growth rate, possibly one that is impossible to achieve. But that's your problem, which in my case is 1.5% plus actual inflation, plus investment carelessness about advisors and taxes. Or personal carelessness about housing costs, travel, fancy automobiles, or fancy friends. it means I could achieve a more likely growth rate of 4.5% a year, keep it up until I'm a hundred, and still be approximately where I am today. It seems achievable.
In fact, as you grow older it is less important to preserve every bit of your assets for the inheritance tax bite on the day you happen to die; particularly since inheritance taxes can go as high as 50%, and you can tell yourself you are spending fifty-cent dollars. Estate tax issues are not today's topic, however. For retirement planning, you could take the ancient advice to "spend your last dollar on the day you die." To entertain this illusion for a moment, you can see how much extra you could afford to spend, by dividing your assets by your life expectancy. You can consider that your safety net, but many people would have to consider it a reality, so this is the rough calculation. If you can't afford to retire on that amount, you probably can't afford to retire. This last calculation gets pretty inaccurate unless you are within five, or at most ten, years of retirement.
So all you need for scaring yourself, or sinking back into complacency, is to calculate that growth factor. Please remember the assumptions you made, in compiling it. Essentially, you total up a year's expenses and a year's income; and subtract to determine how much you are saving, or drawing down your reserves. It seems best to list all of the expenses and income on scratch paper, since at first you will want to go over the whole list to see if the year you picked was truly representative. The first step is to purify the list of one-time or odd-ball expenses and income. The second step is to pick out the expenses which are truly frivolous, which you would quickly eliminate in an emergency of some sort; what are the core expenses, what is truly frivolous, and what is desirable but expendable in a pinch. On the income side, there are pensions and annuities which assure you of cash flow, no matter what. There may be a job you plan to quit, or a pension which won't start for a few years. These are the tools you can use, but the main thing is to get that number, the amount could easily be saving, or the amount you must draw down your assets. Notice that we are essentially ignoring how much your assets happen to be, disregarding whether they happen to be a lucky high number, or an ominously small one. Your goal is to see how much you are either adding to them or subtracting from them; the purpose is to try to project where that will go in the future. In addition, you might also project the gain in your portfolio, but it would require several years to be certain about that, and for now we can get along without it.
Now, project that net gain (or loss) to your hundredth birthday. You may live longer than that, but it isn't likely; and you might live less than that, but you won't care if there is money left over for your estate. You might use a computer program to do it, but computers work by a process of "iteration", which means doing the same calculation, over and over again. For this simple purpose, it will suffice to do it with a pencil and paper, because the chances are good that you can project some future events which will interrupt the smooth flow of estimating one year's income from investment, and adding it to the running total. You soon get to 100, even using the crudest arithmetic, and you soon arrive at the net annual gain or loss in your portfolio at age 100, assuming the present rate of growth. If you do this for a few years, your projection will get more and more precise. You now take this number and re-calculate it with a differing growth rate of the portfolio. Start with 6%, and calculate up and down, 8%, then 4%, then 10%, then 2%, then 12%, etc. You vary the growth rate in a systematic way, and watch to see what growth rate of your portfolio will leave you at age 100, with exactly what you have, today. That's the magic number you want to get, the gross break-even growth rate. If it's a positive number, it tells you what growth you have to achieve in your portfolio, and if it's a negative number, it tells you how much you could afford to squander, you lucky person, over and above your present standard of living.
But now you have to see what could upset your applecart, like inflation. Our Federal Reserve has an announced target of 2% inflation, per year. If that happens, which I rather doubt, I need to add 2% to my 1.5%, getting a "real" target of 3.5% growth in my portfolio per year. That's an approximation of how much my portfolio has to grow, just to stay where it is. In my opinion it's achievable, but events may prove otherwise. Investments which promise less than 3.5% are for me not likely to seem safe, they are losers. Investments which pay more than 3.5% are likely to generate funds I cannot live to spend, so they will only generate inheritance costs approaching 50%. So in that happy case, I could consider giving some away, to my heirs, or charities, or whatnot. On the other hand, some young fellow who is projected to need a portfolio growth of 20%, had better consider getting an extra job, or cutting down his expenses--because the history of investments shows that 20% is either totally unachievable, or else involves so much risk that you better not gamble on it.
There's one other thing you can do if you are old, or sick. You can divide what you have by the number of years in your life expectancy, and spend it down. The goal is to spend the last dollar on the last day of your life. I hope everyone understands how unlikely you are to pull that stunt off, but sometimes it has to be considered. Somewhat more realistic is to adjust your life expectancy in this calculation, from 100 down to whatever age seems more likely. And maybe you have to reduce your lifestyle. Otherwise, your best salvation is not from an investment advisor, but from a social worker.
Try it out. Estimate your required net portfolio growth rate, and then add in "what if". What if the stock market collapses, what if inflation goes to 25%, what if social security gets reduced or increased, what if you suddenly acquire a new dependent. The older you are, and the longer you accumulate your own personal financial data, the more accurate the calculation will be. But at any age and in almost any financial circumstances, fixing your attention on that single number will be a North Star, to navigate by.
Originally published: Wednesday, June 19, 2013; most-recently modified: Tuesday, April 30, 2019