by Joe Hearn | Dec 6, 2016 | Distribution Planning, Income
When planning for retirement, you need to make a lot of assumptions. How long will you live? What will your investment returns be? How much income will you need? When it comes to that last one, most people just estimate their first year of retirement expenses and then adjust that amount higher each year to account for inflation. This seems like a logical strategy. It’s predictable. It provides a steady income. It gives you a raise each year to account for rising costs. There’s just one potential problem. New research shows it’s not how the typical person spends money in retirement.
New spending research
David Blanchett, Michael Finke and other academics have studied how spending changes throughout retirement and what they found might surprise you. Rather than starting at a certain amount and then moving higher with inflation, people spend more in their early years and then gradually decrease spending as they get older. This trend typically continues until later in life at which point healthcare costs cause spending to rise again.
Why is this important? First, your retirement plan is driven by assumptions and perhaps the most important assumption of all is how much you need to spend each year in retirement. If you have that number wrong, your plan won’t be as accurate as it could be.
Second, most people, planners and software assume a static rate of spending in retirement that needs to increase every year with inflation. If that’s not correct—and real spending gradually decreases instead—then we’re overstating the cost of retirement. That means you might be able to retire sooner, retire with less or take a higher distribution rate. Here’s an example to show you what I mean.
In his research, Blanchett found that a household that needed $50,000 in income at age 65 would decrease real spending by about 15% by age 80 and 20% by age 85. Let’s assume you retire needing $50,000 in income and you plan on getting half of that from Social Security and half from portfolio withdrawals. Even if your spending goes down, your Social Security won’t, so any spending reductions can be used to reduce portfolio withdrawals. So if you want to decrease total spending by 20%, then you can decrease your withdrawals by 40%. That means less strain on your portfolio which, as mentioned earlier, means you might be able to retire sooner than expected, retire with less, or spend a bit more early in retirement when you’re healthy and active, knowing that you’ll decrease spending later.
Applications
There are some important ways that you can incorporate this new spending research into your planning.
Make a Core/Discretionary budget: Not all spending changes equally during retirement. Certain core spending on things like food and housing will be with you throughout retirement and are more likely to increase with inflation. It is your discretionary spending—such as travel and entertainment—that will likely decrease as you move through retirement. To better predict how your spending will change, make a budget that itemizes core spending (e.g. grocery money) and discretionary spending (e.g. travel or a new car).
Shrink core expenses: Once you know how your spending breaks down, get rid of as much core spending as possible before entering retirement. Housing is the largest retiree expense and more and more people are retiring with mortgage debt. This is especially easy to justify in a low rate environment. But the downside of servicing a mortgage in retirement is that you’re not servicing it from your paycheck, you’re servicing it from your investment portfolio. If your portfolio drops, you still need to pay your mortgage. That means selling into weakness and increasing your odds of running out of money. Core spending is riskier because there’s little flexibility. Discretionary spending, however, tends to decrease as you move through retirement and you can adjust it if necessary (e.g. postpone your vacation if the market drops).
Rethink your distribution rate: In Blanchett’s research, he found that a 4% initial withdrawal rate over 30 years under the constant spending model has the same approximate probability of success as a 5% initial withdrawal rate if spending changes as discussed earlier (assuming $50,000 in initial spending). If you can take 5% instead of 4%, then you would need 20% fewer assets when you retire. For example, a 4% withdrawal from a $1,000,000 portfolio gives you the same dollar amount as a 5% withdrawal from an $800,000 portfolio.
Stay healthy: Obviously you can’t prevent all illness, but do everything you can to be healthy. This will improve your odds of a long, active retirement and can delay or even eliminate some of the health costs that cause spending to rise later in retirement.
Insure against rising costs: You might be asking, “Why do health costs rise later in retirement? Doesn’t Medicare cover those expenses?” Medicare covers a lot of things, but with very few exceptions, long-term care—where you need help caring for yourself—is not one of them.
What are the chances you’ll need this type of care? Seventy percent of the people who reach age 65 eventually require some form of long-term care. Those are good odds. It reminds me of the time I picked up a rental car in Dublin. I found out the car was a stick, the steering wheel was on the right, you drive on the left, and the place we were going only had single lane roads. The guy behind the counter asked <insert Irish accent> “Are ya gonna be wantin’ the insurance today then?” “Yeah,” I said. “Better give me everything you got. There’s a good chance you won’t be seeing that car again.” The lesson? Insure against bad things that are likely to happen.
Enjoy life: There’s a good reminder embedded in the research we’ve been discussing. If spending decreases as you move through retirement, then for whatever reason, the typical retiree is doing less—either by choice or necessity—at 75 than at 65 or at 85 than at 75. If you retire at 65 and stay healthy and active until 75, then you’ve got 10 years to do everything you’ve been putting off for the last 40. That’s not much time. Be ready to hit the ground running when you retire. Yes, that means the early part of your retirement will be a little more expensive, but if incorporate this new spending research into your plan with the help of a competent adviser and the results hold up, then you should be in good shape.
~ Joe
by Joe Hearn | Nov 2, 2016 | Lifestyle Design, Pursuits
I’m retired. Now what?
I was in L.A. a while back speaking to a group and during the Q&A a lady raised her hand and said something like: “Retirement is harder than most people think. Not necessarily the money part, but figuring out what to do. I thought I’d spend 20 years traveling, but got bored with it after 6 months. Any advice for someone like me who is trying to figure out what my typical day will look like?”
Some version of that question comes up more often than you’d think when I’m speaking to a group or talking with clients. It turns out that daydreaming about what to do with your free time is pretty easy when you don’t have any free time. Once you’re retired, however, and all you have is free time, it can be a challenge to fill your days with interesting and meaningful activities.
So, what advice to give? Thankfully, I’ve written on this topic before (e.g. 10 Questions That Will Help You Decide What to Do During Retirement), so I had a few ideas. What I didn’t want to do was answer her question by suggesting a bunch of activities. “Have you tried Cross Fit? What about volunteering? You could learn to paint. That Bob Ross guy always looked happy.” Somehow, “randomly try stuff” doesn’t seem like great advice.
Instead, I focused on two things. First, I reiterated something that experience had already taught her: Retirement is more than a math problem. Yes, money is important, but the recipe for a happy retirement includes many ingredients and financial security is only one of them.
Second, I shared this quote from Harrington Emerson, an efficiency engineer and management consultant in the early 1900s:
“As to methods there may be a million and then some, but principles are few. The man who grasps principles can successfully select his own methods. The man who tries methods, ignoring principles, is sure to have trouble.”
Methods vs Principles
Let’s unpack that a bit. Think of principles as the laws, rules or beliefs that are foundational to a particular thing. For example, the principles of flight are lift, gravity, thrust and drag. That’s only four things, but if you want to make a flying machine, it needs to tick all those boxes.
Once you understand the principles, you can use any number of methods to accomplish them. In fact, as long as you understand the principles and how they interact (e.g. a heavier plane needs more thrust and lift) then you’re free to do pretty much whatever you want in the design and construction of the craft. It can have a jet engine or propeller. The wings could be made of cloth, steel or some type of composite. It can be big or small. Fast or slow. Have one seat or hundreds. It can serve a specific purpose (e.g. float plane, fighter jet, crop duster) or be a jack of all trades. You get the idea.
Just like with flight, retirement has certain principles that are foundational to success. Things like financial security, meaningful relationships, health, time control, purpose and a sense of belonging, to name a few. Once you understand what those are, you’re free to try pretty much whatever methods (procedures, techniques, tactics) you want to accomplish them. And since a) you understand the principles and b) you know yourself, you can choose methods that both serve the underlying principle and align with your interests, skills, desires and priorities.
Consider our flight analogy again. You’ve probably seen those old videos that show the blooper real of early flying machines. The bicycle with the oscillating bird wings attached. The man jumping off the hill with cardboard wings strapped to his arms. The man on roller skates with…you guessed it…bird wings attached to his arms. It’s clear that these Wilbur and Orville wannabes were doing their best to copy the “methods” of birds without understanding the principles involved that make those birds successful.
Likewise, retirees will sometimes copy things like golf, travel or relocating without realizing that they’re confusing principles and methods. Travel is not a principle of retirement. Having meaningful pursuits is. Volunteering is not a principle of retirement. Purpose is. Tennis is not a principle of retirement. Being healthy is. If you ignore the principles or don’t understand them, any method you try will feel random, ineffective, unstructured and ultimately disappointing. But if you understand the principles then, to paraphrase Emerson, you’ll have unlimited methods to choose from and you can experiment and settle on those which suit you best.
Be Intentional,
Joe
by Joe Hearn | Aug 25, 2016 | Pursuits, Travel
“Oh. Sorry. You’re on the wrong side of the mountain.”
That was the response I got when I called the park ranger help line. The number was conveniently posted on a big “You Are Here” board which I got out of my car to examine because it happened to be right next to the “Dead End” sign that marked the end of the road.
This new information presented a problem because my wife and I were planning to climb Mt. St. Helens and we needed as much daylight as possible to do it.
It was 10 am and we were at the aforementioned dead end, staring at the familiar crater in the distance of the mountain that erupted in 1980 with the force of 21,000 atomic bombs. We spent the previous night at Paradise Inn on Mt. Rainier and got up early for the trip to St. Helens. It’s only 35 miles as the crow flies, but three hours for any non-bird transportation that needs to follow the winding roads. Unfortunately, my poor navigation skills would now add another hour and a half to that.
Oh well. Back in the car. If it sounds like we didn’t spend much time planning this excursion, it’s because we didn’t spend much time planning this excursion. We didn’t even know we’d be climbing it until the week prior. The park service only allows 100 people per day to climb the mountain and all of the required permits had sold out months earlier. I found a website where people sell or trade permits they can’t use and kept checking for sales that matched our dates. At the last minute, an engineer from Nike decided that climbing an active volcano with his kids might not be as fun as it sounds, so I bought his permits.
We made it to the other side of the mountain by about 11:30 and found Climbers Bivouac, which is the beginning of the Monitor Ridge Route that leads to the top. As I put our information into the book at the trailhead, I saw, not surprisingly, that everyone else on the mountain that day had left hours earlier. “We won’t make it to the top,” I told my wife. “We’re starting too late. Better that we get that through our heads now.”
But as we started through the forest, I kept checking my watch and realized that we were making great time. The hike is 10 miles round trip and the first two miles of that are fairly easy. Then you break through the tree line and come to a boulder field that slows things to a crawl. Literally. We spent much of the next several miles and 2,500 vertical feet on all fours crawling over boulders the size of Volkswagens. I quit checking my watch because it was too discouraging.
The boulder field
At one point, we crossed paths with a climber on his way down and I was bemoaning our late start. He assured me that we were almost to the ash field. That’s the last mile and 1,000 feet of vertical. As a veteran of the St. Helens climb, he said we were lucky today because recent snow melt had compressed the ash and we would only sink to our ankles with each step. “Lucky us,” I said. “How far do you normally sink?”
“Sometimes shins. Sometimes your knees,” he said. “It’s usually one step forward, sink, slide back a half step.”
I tried not to make eye contact with my wife. When the climber moved on, I suggested we stop for a snack. “This is usually the part of the trip where I apologize for getting people into this,” I said. I told her if we tried for the top, we’d be coming down in the dark and then we had a four hour drive back to home base in Sequim. Best case scenario, we get home really late. Worst case scenario, we spend the night sleeping in the boulder field.
“It would stink to get this far and not see the view from the top,” she said. On we went.
We made it through the boulders and, sure enough, the ash was only ankle deep. Normally, that would have been a discouraging development, but now that I knew how much worse it could be, we were happy. Perspective is a funny thing. Unfortunately, there were no switchbacks on the route so the climb was very steep and slow.
Going down looked much more fun. The trail was bracketed in by two snow fields and several people who had summited earlier were glissading down the snow pack, using ice axes to slow their descent.
The ash field.
We kept on and finally (FINALLY!), the terrain leveled off and we were at the summit. It was a clear day and the views were incredible. Mt. Hood was visible to the South and it felt like you could almost reach out and touch Mt. Rainier to the North. Inside the crater is a bulging dome that is growing every year as the volcano below churns.
After taking some photos and enjoying the view, we donned our packs and started down. The descent went much faster, but the sun had set and it was nearly dark by the time we reached our car. We made it home in the small hours of the morning and crawled into bed still covered in sweat and ash, but I wouldn’t trade the experience for anything. Beautiful scenery. Time with my wife. A sense of accomplishment. A fun memory. Those are some of the things that make life great.
Trip Details:
Want to climb St. Helens? Here are some of the details:
Distance: 10 miles round trip
Average completion time: 8-10 hours
Summit elevation: 8,363 feet. It was 1,300 feet higher before the blast.
Elevation gain from trailhead: 4,500 feet
Gear: Good boots, poles, food, water, layered clothing, sunscreen, etc.
Planning Info: Here
Permits: Get one here
If they’re sold out: Try here.
A panoramic of my wife at the crater rim. For scale, there is another person on the far right of the pic.
by Joe Hearn | Jul 21, 2016 | Retirement
The headline from a recent study caught my eye: “Majority of retirement plans done ‘in people’s heads’ or not at all.” I think the latter is more likely. Doing a retirement plan in your head is kind of like reciting Pi out to a hundred decimal places or trying to list off all of the Samuel L. Jackson movies from memory—I don’t doubt that there are people who can do it, but most of us would give up if we tried.
Why? Because retirement plans are complicated and have a plethora of moving parts. It’s not just deciding that someday, maybe, depending on how things go, you might just move to the beach. It’s deciding what (specifically) you want to do, what that’s going to cost, and where that money will come from. It’s creating a retirement budget and a distribution strategy. It’s considering things like Social Security, inflation, longevity, sequence risk and dozens of other variables. That’s more than most of us can calculate and keep straight without bringing pencil and paper (and a computer) into the mix. Having a few vague plans in your head won’t cut it. You should have a written retirement plan. Let’s look at how to make one.
Where am I?
A good retirement plan answers three questions. Where am I? Where do I want to be? How am I going to get there? Answering the first question is fairly easy. Just sit down and gather some basic information about how much you have saved for retirement so far. Add up things like your IRA, 401(k), pension, annuities, cash value life insurance, real estate, brokerage accounts and any other assets or income streams (e.g. Social Security) that you plan to use to fund your retirement.
Where do I want to be?
Next, you need to figure out what you want to do in retirement and what those things are going to cost (a.k.a. Where do I want to be?). Your plans will drive your income needs, so you need to have a good idea of when you want to retire, where you want to live and what you want to do. All else being equal, you’ll need more money if you want to retire at 60 in Italy to join the semi-pro bocce ball league than if you want to retire at 70 in Omaha and volunteer at the humane society.
So think like a journalist and ask the who, what, where, when and why of your retirement. If you’re married, go through this exercise with your spouse. Be as specific as possible. For example, don’t just say, “I want to live in California.” Say “I want to rent a 2 bedroom condo in San Diego.” Don’t just say, “I want to get outdoors more.” Say “I want to visit all 59 National Parks.” The more specific you are, the easier it will be to estimate costs.
Which leads me to my next point. Once you have a good idea of what you want to do, you need to figure out what those plans will cost. Ignore inflation for the time being. In other words, if you want to retire at 65 and you’re 55, don’t try to guess what your plans will cost in ten years. Just do some research to figure out what they’d cost today and you can adjust that for inflation later.
To help outline your expenses, you can download my free Retirement Budget Worksheet. Go through line by line and come up with your best estimate for what you think you’ll spend each year in retirement.
Quick note: Some of you may be wondering about things like the 80% rule of thumb. That’s the assumption that many people can get by in retirement on about 80% of their pre-retirement income. In my opinion, having a specific line item budget is preferable to a general rule of thumb because it will give you a more realistic estimate of your costs.
How am I going to get there?
This is where things get tricky. There are so many variables involved with the typical retirement plan that you need to bring some expertise and computer power to bear. If you have the expertise, but just need some help with the calculations, there are a number of online calculators available. A word of warning, however. Many free calculators are very basic and make a number of unrealistic assumptions. To avoid a plan that is “garbage in, garbage out,” be sure to choose a calculator designed to do serious planning.
If you don’t have the time or expertise to do the planning on your own, it’s probably a good idea to hire an adviser who specializes in this type of planning and who has access to sophisticated planning software that factors in taxes, inflation, sequence risk and a host of other variables. A good adviser will also make sure your plan is comprehensive and covers key areas like savings goals, distribution planning, cash flow management, risk management, pension payouts, asset allocation, insurance, Social Security, Medicare, long-term care, debt and more. Finally, if there’s a shortfall between where you are and where you want to be, an adviser can help devise a plan to bridge the gap. There’s obviously a cost associated with hiring an adviser, but you will also likely end up with a plan that is more accurate, realistic and tailor-made for you.
The payoff
As you can see, there is a lot of work involved in creating a written plan, but it comes with a number of benefits. Done properly, your plan gives context to your financial life. Gone are the days of just saving randomly and hoping it will be enough. With a plan, you can know for sure whether you’re on track to meet your goals. You get clarity and peace of mind. You get financial security. You get on the same page with your spouse. You get a clear vision for the future. I’ve done hundreds of these plans for clients over the years and I’ve never had someone tell me that they regret doing it. The payoff is definitely worth the effort.
~ Joe
Photo Credit: Nick Kelly.
by Joe Hearn | Jun 17, 2016 | Happiness, Health
What makes a good life? Now there is a question with universal appeal! Who wouldn’t want to know, in advance, what types of things would make them healthier, happier and more fulfilled?
Unfortunately, research shows that we’re not very good at predicting what will make us happy. I call this the “I want to be rich and famous and then all my problems will be solved!” fallacy.
Just because we’re not good at predicting, however, doesn’t mean that we’re destined to a lifetime of trial and error in search of the holy grail of happiness. There is plenty of research on what works. Indeed, one of the longest studies has been going on for the last 75 years.
It’s called the Harvard Study of Adult Development. Started in 1938, the study follows two groups of people. The first group was made up of 268 Harvard sophomores. The second group was made up of 456 young men from inner-city Boston.
Every other year, researchers follow up with the surviving study participants and interview them extensively about everything from their finances and careers to their relationships and social activities. Then every five years, they do an extensive evaluation of each participant’s health, including x-rays, blood tests and echo cardiograms.
Robert Waldinger, the current director of the study (he is the 4th over the past 75 years), detailed some of the key findings in his excellent TED Talk. Here is a summary:
- Relationships and social connections are really, really good for us. They make us happier and healthier and they help us live longer. Those in the study with good relationships experienced all of those positive outcomes. Those in the study who described themselves as lonely, however, had a shorter life expectancy, reported being less happy and had worse mental and physical health.
- The quality of our relationships makes a big difference. The better the relationships, the more positive benefits people experienced. Participants who were the most satisfied in their relationships in their 50s were the healthiest in their 80s.
- Good relationships protect your brain. Participants who reported having good relationships and being in healthy marriages had minds that stayed sharper longer and they performed better on memory tests.
So back to our original question. What makes a good life? Rather than focusing on wealth, career or material possessions, the Harvard study shows that we would do well to focus on close, healthy relationships. Again, Robert Waldinger: “…over and over, over these 75 years, our study has shown that the people who fared the best were the people who leaned in to relationships, with family, with friends, with community.” Keep that in mind as you live life and plan for retirement.
~ Joe
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