Monday, May 02, 2022

Retirement Is Really Complicated

 An in depth Random Roger investigation has discovered that retirement income is complicated. That's stolen from the TV show PTI.

The ink had barely dried on yesterday's post about fear of spending retirement funds in retirement when Michael Batnick and Ben Carlson had retirement expert Wade Pfau on their podcast talking about the same thing. This idea has been pinging around for the last couple weeks, beyond the Barron's piece that was the catalyst for my post. 

The most interesting part of their conversation was the recent revelation that Bill Bengen, the author of the 4% rule is not comfortable owning enough equities for his version of the rule to work. It takes 50% and he is at 20%. This hits on a couple of long standing themes on this blog to circle back to.

The simpler one is that you never know what the future you will want to do. The application here is, you don't know how your tolerance for equity market volatility will change, if it will change when you're older. What works at 60, might not work at 80 or some other age. A scenario where an investor retires at 60 pretty much on target for the number he needs, so not a huge margin for error, and keeps 60% in equities to maintain that stasis. Let's say this investor is now 77, very fit and healthy and just can't sleep with 60% in equities for whatever reason. He's needed 60% in equities to keep up. If he goes to 20% equities as Bengen has apparently done, how likely is it that he will continue to be able to keep up? If he's that fit, he's got to figure out how to make it work for many more years.

I've never been a fan of the 4% rule as widely adopted which is you start at 4% and increase it every year by inflation. It is silly on it's face that someone is going to increase their quarterly, portfolio paycheck by $275 or $415 or whatever, I just don't believe it. It is an extra layer of minutia. For years, I have been saying whatever you got, 4% . More specifically, 1% every quarter. Stock market growth will take care of the inflation math for you. Years ago, a reader quipped that if you do that, you'd never run out of money but he meant it as a criticism. It was a legit point taken in full context. The variable though is the one-off expenses. I think whatever you got, 4% allows for being better able to pay for large one-off expenses versus being 6 years in, your withdrawal rate is now 6%, stock market is down 20% and you need $30,000 to cover helicopter ride when you broke your leg skiing. You have a balance every quarter, whatever that is, you take no more than 1%. The downside of whatever you got, 4% is yes your paychecks will be lumpy.

I like the idea of building this backwards, starting with what your expenses are expected to be, is there any fat to be cut and to make sure you're not forgetting something in your budgeting process. For example, you probably don't need to save for retirement after you've retired. Your expenses are not some rule of thumb percentage of your income. That's a lazy approach. Take out a spreadsheet, input your numbers, what is the total? From there I would suggest padding it but some amount you think prudent for unbudgetable one-off expenses and add a realistic number for discretionary spending. 

In today's dollars our fixed monthly expenses ten years from now look like $3200. I doubled the cost of health insurance, and took a bunch of annual expenses like property tax and divided by 12. From there, I would add $1000 for one-offs and $1500 for discretionary. So we'd need $5700 which is a little higher than it was for us, five years ago. Where is that going to come from. What is your number and how will you cover it when you retire, if you retire?

First, if you don't like your number using this process, how can you reduce it? Now, how will you build an income from various sources to cover that number? What will you get from Social Security? Worried about SS solvency or a payout reduction? The number being thrown around on that front is 23%. Applying that haircut to your expectations seems prudent for this exercise. 

How much can you safely take from your portfolio? How much is 4%? How much is 3%? Is covering the gap between your need and SS payout, if there is one only, going to come from your portfolio? If so, do the numbers work? If they work, what is your margin of safety? If they do not work, what can you do about it? Can you spend less, save more, find a third source of income? 

A path that I think can solve portfolio shortages, real or perceived is that third source of income, whatever that might be for you. With enough time both in terms of time spend on the endeavor and time horizon needed to ramp up that third income source, the third one could actually be second income stream making your portfolio the third stream or supplanting your portfolio altogether at least for a time. 

We talked about this in yesterday's posts and I've been writing about it for ages as relieving the burden from your portfolio. Back to my personal numbers, if our investment portfolio needed to produce $2000/mo and I found some sort of gig that reliably brought in $500, in percentage terms, that is a big chunk of portfolio income I am getting somewhere else. 

The more of the burden you relieve and for longer then obviously your retirement finances are going to be a whole not easier. This is a problem for each of us to solve in whatever way can individually. Learn the difference between generic rules of thumb that border on useless versus building your own solution. Having built something from the ground up that you fully understand will also allow you to tweak it later if your circumstance dictates that you do so.


Anonymous said...

Another way is to front load your first 3 or so years in cash reserves, and the balance in equities. Fill the cash bucket during opportune times. The x years in cash reserves protects against sequence of return risk out of the gate.

Roger Nusbaum said...

agreed, written many posts on sequence of return risk.

Sequence Risk and Allocations

Barron's had a couple of good articles over the weekend, one was an interview with Harold Evensky about sequence of return risk and the...