What Ugly Financial Surprises Await You in Retirement?
We just finished reading, “The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness,” by Morgan Housel. The book is one of the best financial and psychology books out there to describe how our own limited experience hurts our ability to make good financial decisions. The premise is that we can typically only “know” what we experience, and we assume that what we’ve experienced will be what happens down the road.
Here are a few examples. Before 1984, the top tax bracket was never below 70%. Baby Boomers were just coming into their own- many of them never paid these high rates, and Generation X and Millennials certainly never did. According to data from Freddie Mac, the average 30-year fixed mortgage rate dating back to 1971 is 7.9%. However, in the last decade, and Millennials are buying their first homes, the average rate was only 3.93%. Expectations about employment and income, investment returns, economic growth- all of these and more tend to be set by what we have experienced in the past. If we haven’t experienced these economic circumstances they are harder to imagine.
If you can’t imagine alternate scenarios, you can’t plan for them.
This is particularly dangerous when in retirement you may not be able to change course as easily. Since none of us has a crystal ball, what do you do?
The first thing we try to do at The Planned Approach is plan for what Warren Buffett refers to as a “Margin of Safety”. Simply, this is overestimating what you need so you that you will be more likely to have enough if your assumptions are incorrect. If you are planning on spending your last dollar on the same day you take your last breath, assuming that everything will go right in your planning, or assuming none of your assumptions are incorrect, chances are you may run out of money. Plan a nice buffer.
We also attempt to Plan for Flexibility. We don’t know how future tax rates, inflation rates, market returns, health care costs, or many other factors will turn out to impact your retirement plan. We choose not to bet on one single set of assumptions, but instead plan for multiple scenarios. The goal is to be able to skin the cat in alternate ways, depending on what actually comes to fruition.
We encourage clients to Live Below Your Means, Not at Them. In the almost 20 years we have been in business, what doesn’t surprise us anymore is how much better off those are that live well below their means and are content doing it. Now this is not to say that people should not live great, fun lives- they should! However, it does mean they should be careful not to over-withdrawal from investments early, not to commit to big, fixed expenses that are expensive to drop or change if they need to. It also means people should think about how they spend to make sure enjoyment doesn’t turn into gluttony that isn’t even enjoyed.
Finally, auto-pilot when it comes to your financial planning doesn’t work. We work hard to Watch and Adapt as times change. This means looking each year at the structure of investments, but also the income strategy. We don’t want to sacrifice future options because we used up too much too early- whether it be an asset class we may need later or a tax-free account.
Many people make great money trying to convince others they know what is coming next. The reality is that no one knows. If security is important for you after your years of hard work, be aware that you are limited by your experience and should plan for the unexpected.