If you have ever been sailing on San Diego Bay, you know how peaceful it can be on the water, with only the wind in your sails moving you forward. If you are a pre-retiree or already retired, you probably strive for that same peaceful, easy feeling in retirement. When sailing, you know the feeling when the wind fades and progress slows or totally stops and you are no longer going in the direction or at the speed you thought you would when you started your journey. Without the wind, you have decisions to make about adjustments to your plan or you face changing course altogether.
Sailing, like life, can be a journey full of uncertainties from wind speed and direction to tides and swells. Even the hidden elements like the heat from the land can affect the direction of the wind, sending you tacking into uncertain territory. Analyzing the elements and having the ability to make tactical adjustments to your sails can help you move in the direction you intended when you started. Planning to and through your retirement takes that same focus.
Sailors and retirees both fear running out of something during their journey. For retirees, undoubtedly, one of the greatest concerns is running out of money during a retirement period that can last 30+ years. Concerns can range from paying for rising healthcare costs and making decisions related to paying off debt to figuring out the best place from which to withdraw the money you will need to live on. It is important for pre-retirees and retirees to have a solid plan in place that includes a sustainable approach to taking withdrawals from an investment portfolio when needed. So how do you plan and finally embark on your retirement journey? A safety checklist is a good place to start.
1. Understand your spending habits and identify discretionary and non-discretionary expenses.
The weather forecast is something a sailor should always be aware of before leaving the safety of the dock. Like sailors, retirees should be aware of their spending habits before leaving the safety of a consistent paycheck and should be able to identify those areas of spending that are discretionary in nature. These discretionary expenses are like the sails of your boat that can be adjusted, if needed, as you wait for the wind to fill in to put you back on course.
2. Have a plan in place to keep you on course during your journey.
Having a financial plan in place to document your needs and goals should be the foundation of your retirement journey. Think of your financial plan like the compass that helps the sailor stay on course. It is the equipment you need to check your progress and direction.
3. Determine the amount you will need to withdraw from your portfolio and make sure your asset allocation is aligned with your goals.
Establishing a withdrawal strategy from your portfolio to cover your cash flow needs can be complex and should be well thought out to take into consideration things like taxes and required minimum distributions. Equally important (and just as complex) is establishing the appropriate mix of investments within your portfolio so when you need money, there will always be a smart place to get it from. Your portfolio must be designed to weather through market fluctuations and provide for spending, but also be balanced enough to fight off the effects of rising inflation. Think of your portfolio and asset allocation like the keel of your sailboat, which prevents the boat from being blown sideways but also holds the ballast that keeps the boat right-side up.
4. Closely monitor the first few years of portfolio value to confirm its life expectancy.
There have been many distribution strategies introduced over the years that help determine “safe withdrawal rates.” Strategies include the 4% rule, withdrawing fixed dollar amounts each month, a “bucket” approach, and more. What many of these strategies fail to address is the uncertainty of portfolio returns, inflation, and unexpected expenses from year to year. We refer to this as the sequence-of-returns risk. It is the risk that an investor who enters retirement experiences a market correction early on and must take sizable withdrawals from the portfolio to cover expenses. This set of circumstances is oftentimes unavoidable and could prove to be detrimental to the longevity of a portfolio. Let’s look at an example to illustrate this risk.
Investor 1 and Investor 2 start retirement with $100,000 in their portfolio and both experience the same rate of return but in reverse order. Given these assumptions, the table below illustrates that both investors arrive at the same destination after five years.
In the next table, the rate of return assumptions remain the same, but now we add in a $10,000 withdrawal from the portfolio at the beginning of every year to cover living expenses.
At the end of five years, the investor who experienced market declines earlier is in a much different situation than the investor who experienced positive market advances earlier, even though both investors spent the same $10,000 per year.
This goes back to what we learned in Finance 101: “a dollar today is worth more than a dollar tomorrow.” The investor who had more money to invest earlier ended up with more money in the end, even though both investors spent the same exact amount each year. Remember, the earlier you retire, the longer your savings will need to last, which can put additional pressure on your investment portfolio, especially during market volatility and low yields from bonds.
At CCMI, we address the certainty of uncertainty by testing our financial plans using an analysis simulation called Monte Carlo. The Monte Carlo analysis illustrates the potential results using 1,000 randomly generated market scenarios of varying returns and volatility. The result of introducing random investment volatility to the analysis produces a range of values that demonstrates how changing market returns may impact future plans and portfolios. Like all strategies, this analysis is not perfect because it is based on a set of historical assumptions, but it gives us a guide to address market volatility in the absence of having a crystal ball.
The illustration above shows the importance of preparing an investment portfolio for spending withdrawals. Each year, we review our clients’ financial plans to ensure we have stayed on course. Choosing when to retire, one of the most important decisions of your life, should not be guessed at or left to chance. Planning ahead and during retirement is critical.
Our advice is to be prepared for the weather, control what you can, and make adjustments when they are needed. Whether you’re embarking on a sailing journey in San Diego or your own retirement journey, being prepared and continually checking your progress will give you the best odds for a successful outcome.
To recap, here is our checklist:
As you know, life rarely goes exactly according to plan. The retirement plan you have in place should allow room for you to tack and jibe when the weather changes to keep you on your course and moving in the right direction. If we can help you set that course, please reach out to us. It would be our pleasure to embark on and navigate the journey with you.
CCMI provides personalized fee-only financial planning and investment management services to business owners, professionals, individuals and families in San Diego and throughout the country. CCMI has a team of CERTIFIED FINANCIAL PLANNERTM professionals who act as fiduciaries, which means our clients’ interests always come first.
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