After a week “off” at Disney World, the briefing room is back in session with some perspectives on the benefits of a good plan. For those who have endured a Disney park with small children, you probably know all too well that there’s no real “off” time when it comes to optimizing a trip to the Magic Kingdom. It had been several years since we had been to Disney, and I was surprised at the crowds (which I was told were normal as I was standing shoulder-to-shoulder with thousands of my closest friends watching Mickey wave from a passing parade float). I had also forgotten about the “Disney Dash,” or the mad race into the park as soon as the rope drops and the crowds are admitted. This certainly wasn’t Augusta; there were no polite speed walkers carrying their chairs to the Amen Corner. In fact, running seemed to be encouraged regardless of the density of the crowds or the trail of bewildered children that were left behind the stoic and sleep-deprived dads on their march toward Space Mountain.
I’ll be the first to admit that I underestimated the benefit of a solid Disney World plan. From Fast-Passes to dining to timing the monorail, we found that we could smooth the day’s events and ensure a more enjoyable time (and less stressful) by formulating a plan of action before we headed out for the day. It seemed silly at first — after all, we had done enough planning to simply get the family to Florida in one piece. The planning part was over, wasn’t it? As we quickly found out, the really important planning only started once we got to our destination.
Retirement planning is very much similar. We tend to focus on the hard work leading up to our golden years, but rarely do we spend the required effort planning for life in retirement. We need to plan on arriving at retirement, but the process shouldn’t stop there.
Before our trip I spent a morning listening to Dr. Wade Pfau, Professor of Retirement Income at The American College. It was a fascinating lecture, and Dr. Pfau hit on some of the “Retirement Risk Juggernauts” that we address with our planning and asset management services. Here are a few that I’d like to spend some time on:
- Volatility
- Spending
- Liquidity
Volatility hurts in retirement. As Dr. Pfau showed, sequence risk — or the path that your investment returns take as you approach retirement — has a huge impact on a financial plan’s success. Specifically, drawdowns later in your working years have a more detrimental effect due to the size of the portfolio and the limited ability to invest as working income ceases. In fact, the first year in retirement poses the most risk for investors as far as market return is concerned. For those that retired at the close of the 2007 bull market, the story is all-too familiar: the global financial crisis and its impact on portfolios left many retirees seeking a return to the workforce to shore up retirement funds. Since you can’t control when you were born or market cycles, what can you do? Here are some of the solutions that we investigate and employ with clients:
- Align portfolio risk with individual risk tolerance and objectives
- De-risk by holding fixed income to maturity and reducing equity exposure during the initial years of retirement
- Create a portfolio floor (in exchange for capped upside gains) using derivatives
As far as spending is concerned, the old 4% rule (the maximum “safe” withdrawal rate that an investor can take from his/her portfolio per year) has been challenged from various perspectives, to include differing portfolio allocations, investment horizons, and unknown market risk. A comprehensive financial plan helps households create and understand their balance sheet, as well as prioritize essential spending and discretionary spending (using defined goals). With an understanding of needs and wants, we can help clients fund a hierarchy of “buckets”:
- Essential lifestyle needs
- Rainy day “bucket”
- Discretionary or “wants”
- Enduring legacy or generational wealth transfer
From a withdrawal perspective, the folks over at Morningstar have done a great job comparing the various strategies. You can read the paper here. The quick version is that they recommend combining the Required Minimum Distribution methodology that the IRS uses (to update mortality probabilities) with a Probability of Failure strategy. In other words, we keep our probability of portfolio failure within a specified tolerance (say 10%) while adjusting for life expectancy.
Speaking of rainy day funds, liquidity brings an interesting challenge to the puzzle. Some insurance products offer a cash value that could provide an emergency liquidity injection, but cashing out may be expensive. Additionally, as Dr. Pfau points out, liquidity is usually not the driving reason behind obtaining an insurance product. Assets may be liquid in the sense that they can be bought and sold with relative ease, but we’ve seen several mutual funds lately that have stopped redemptions or offered shares in other stocks instead of the cash value of the investment. Additionally, selling off investments to fund near-term needs is the retirement equivalent of robbing Peter to pay Paul — something down the road is probably going to go unfunded. For this reason we recommend establishing a liquid reserve to help fund near-term contingencies and researching insurance solutions to ensure appropriate coverage for real assets and/or medical needs.
These are a lot of items to think about as we enter retirement. Too often we’re so excited/exhausted that we miss the most important stage of the planning process. Just as I stood dumbfounded on Main Street U.S.A. trying to keep our Disney vacation on track (in real-time no less), many Americans nearing or entering retirement feel the same way. Last year, Northwestern Mutual released a survey that indicated 58% of polled Americans believed their planning efforts needed improvement and 34% had no plan at all. CNBC carried the story here if you’d like to peruse it.
We help take the mystery out of financial planning and assist our clients in developing a robust plan that addresses their goals before and during retirement. We’d love to help you begin the planning process — we can be reached at 1-888-832-4939.
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