Retirement Planning Games

Disclaimer: By the time you finish reading this, it will be obvious that I’m not an expert on retirement planning.   None of this should be construed as advice, just my experience of the process, a process I wish I’d started sooner.   What may not be obvious is how grateful I am to have what we have to plan with.

If you’re lucky, sooner or later, you’ll reach a ripe old age with enough invested to wonder if your pile of money will last you for the rest of your life.   Of course, if you’re really lucky, your pile of money is so big that you don’t have to wonder.    I’m not sure how big that pile would be.   You can find some rules of thumb, though.  For example, in an article from Kiplinger’s Personal Finance Magazine, Van Harlow, president and chief investment officer for Fidelity Asset Management Services, recommends that you figure out how much income you’ll need to draw from personal savings in your first year of retirement and then multiply that by 25.   If that sounds like a lot of money, it is.   Others suggest that about half of that is adequate.   Still a lot of money, though, so if you’re young right now, think about it … because you’ll be thinking about it later, when the size of your pile is already determined.

So, you reach your sixties, planning to work for a few more years … and the economy tanks.    You’re retired … not totally resigned to it but enough so to require some planning.   You look at your pile of money and try to answer the question:  Will it last?  Let the Retirement Planning Games begin.   The arithmetic is simple.    Your pile of money earns interest each year.  Each year you take money out to live on.  If you take out more than your money earns, then your pile gets smaller.   To determine if your money will outlast you, you have to play Retirement Planning Game Number One:  Guess How Long You’ll Live.    Guess longer and you need to live on less each month, guess shorter and you risk being wrong and outliving your money.   A sobering exercise in recognizing one’s mortality.

So, OK, you swallow hard and say, I think I’ll live for 25 more years.   You think back … in 1985, a gallon of gas cost about $1.20 and now, you’re paying about three times that.   You vaguely remember paying $1.10 for a loaf of bread and the last time you were in the local market, you paid $2.75.    Housing prices have approximately doubled over the last twenty-five years but before the recent bubble burst, they were up by a factor of four in some places.  Yet the price of apples has hardly changed.   Welcome to Retirement Planning Game Number Two:  Choose Your Inflation Rate.    You know the amount you need will increase each year … but how much?    Chances are, as a senior, you’ll be below the national average.   After all, your housing costs may be fixed or go down … you’ll probably eat less and manage with that aging Camry longer.    But what’s your number?   You look at the annual inflation rate over the last twenty-five years and you notice inflation has been as high as 5.4% (in 1990) but your broker says his people predict 2.3%, so you go along (pretending not to notice that in 1980 inflation was over 13%).

But you need one more number – Retirement Planning Game Number Three:  Choose Your Rate of Return – and if you thought Retirement Planning Game Number Two was hard, you’ll hate this one since the stock market is even more inscrutable than the inflation rate.   Of course, you could make it easy by having all your hard earned investments in the local bank … then the number is  1.25% … and unless you’re really rich, you’re screwed.   Chances are, your investments are diversified … some stocks, some bonds, some money market, some whatever.    Your broker has his team of experts predicting the rate of return in every investment category and he says Use 7.5%.    You say OK, wondering why his experts didn’t get you out of stocks two years ago when the market headed south.

Now, you’re ready.   Your financial guy runs his models … and if you’re a techie, you write your own financial planning spreadsheets in Excel or programs in MATLAB.  And out pop your predictions.   You’re OK.   You’re a little short.   You’re a lot short.   Changes are required.   Cutting back.  Downsizing.   Not easy changes, so you want to be sure you believe your results before you proceed.   You change your numbers a little bit and suddenly, the results say you’re OK.   Yikes.   The wonders and pitfalls of compounding interest.   Your broker runs some Monte-Carlo simulations and tells you that you’ve got a 30% chance of your money lasting.    You’re a scientist and have been doing statistical simulations all your life.   You’ve heard (and believe in!) the somewhat off-color maxim:  Simulation is like masturbation … the more you do it, the more you think it’s the real thing.   And just you read an article on the flaws of Monte Carlo simulations for retirement planning.   Welcome to the Bonus Round of Retirement Planning Games – What Can You Believe?, the subject of a future post.

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Tags: curmudgeonly rants, feeling older, financial downturn, perspectives, retirement

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