As I have attempted to summarize the key
messages and themes that have underscored my writing and research, I find that
the following eight guidelines serve as a manifesto for my approach to retirement
income planning. It is helpful to start with these guidelines because I will
ultimately talk about how to implement these guidelines in practice.
Play the long game
Retirement income plan should be based on
planning to live, not planning to die. A long life will be expensive to
support, and it should take precedence over assuming one will not live long.
Fight the impatience that could lead you to choose short-term expediencies
carrying greater long-term cost. This does not mean, however, that you
sacrifice short-term satisfactions to plan for the long term. Many efficiencies
can be gained from a long-term focus that can support a higher sustained
standard of living.
Retirees must still plan for a long life, even
when rejecting strategies that only help in the event of a long life. Remember,
planning for average life expectancy is quite risky—half of the population
outlives their expectancy. Planning to live longer means spending less than you
otherwise would. Developing a plan that incorporates efficiencies that will not
be realized until later can allow more spending today in anticipation of those
efficiencies. Not taking such long-term, efficiency-improving actions will lead
to a permanently reduced standard of living.
Do not leave money on the table
The holy grail of retirement income planning is
finding strategies that enhance retirement efficiency. I define efficiency as
follows: if one strategy allows for more lifetime spending and a greater legacy
value for assets relative than another strategy, then it is more efficient.
Efficiency must be defined from the perspective of how long you live. Related
to the previous point, a number of strategies can enhance efficiency over the
long term (but not necessarily over the short term) with more spending and more
Use reasonable expectations for portfolio
A key lesson for long-term financial planning is
that you should not expect to earn the average historical market returns for
your portfolio. Half of the time, realized returns will be less. As well, we
have been experiencing a period of low interest rates, which unfortunately
provides a clear mathematical reality that at least bond returns are going to
be lower in the future. This has important implications for those who have
retired. (These implications are relevant for those far from retirement as
well, but the harm of ignoring them is less than for retirees.) At the very
least, dismiss any retirement projection based on fixed 8 or 12 percent
returns, as the reality is likely much less when we account for portfolio
volatility, inflation, and a desire to develop a plan that will work more than
half the time.
Be careful about plans that only work with
high market returns
A natural mathematical formula that applies to
retirement planning is that higher assumed future market returns imply higher
sustainable spending rates. Bonds provide a fixed rate of return when held to
maturity, and stocks potentially offer a higher return than bonds as a reward
for their additional risk. But a risk premium is not guaranteed and may
not materialize. Probability-based retirees who spend more today because they
are planning for higher market returns than available for bonds are essentially
“amortizing their upside.” They are spending more today than justified by bond
investments, based on an assumption that higher returns in the future will make
up the difference and justify the higher spending rate.
For retirees, the fundamental nature of risk is
the threat that poor market returns will trigger a permanently lower standard
of living. Retirees must decide how much risk to their lifestyle they are
willing to accept. Assuming that, a risk premium on stocks will be earned and
spending more today is risky behavior. It may be reasonable behavior for the
more risk tolerant among us, but it is not a behavior that will be appropriate
for everyone. It is important to think through the consequences in advance.
Build an integrated strategy to manage various
Building a retirement income strategy is a
process that requires determining how to best combine available retirement
income tools in order to meet retirement goals and to effectively protect
against the risks standing in the way of those goals. Retirement risks include
longevity and an unknown planning horizon, market volatility and macroeconomic
risks, inflation, and spending shocks that can derail a budget. Each of these
risks must be managed by combining different income tools with different
relative strengths and weaknesses for addressing each of the risks. There is no
single solution that can cover every risk.
This article is part of a series; click here to read part Two.
This is an excerpt from Wade Pfau’s book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. (The Retirement Researcher’s Guide Series), available now on Amazon.
Originally posted at https://retirementresearcher.com/the-retirement-researcher-manifesto-part-one/