Warren Buffett once said, “It’s only when the tide goes out, that we find out who’s swimming naked.” Now, depending on your stage of retirement, you may want to heed this advice and ensure your swimsuit is on and fully secure. I believe Mr. Buffett’s analogy means that it’s when the going gets tough when we find out who is prepared for retirement and who is not. In planning for retirement whether you are 15 years out, five years out, recently retired, or a seasoned retiree, engaging in the proper planning can pay huge dividends, not to mention save you from the revealing embarrassment of falling tides.
How to Avoid Swimming Naked in Retirement
I view retirement planning as two separate, but not mutually exclusive, categories: determining your Personal Benchmark and understanding Three Major Retirement Risks and having a clear strategy to manage these risks. Let’s first discuss the Personal Benchmark, and then we will discuss risks.
Your Personal Benchmark
It’s all about YOU: YOUR goals, YOUR objectives, YOUR money, YOUR retirement. The first step in planning one’s retirement ought to follow a process like this:
- Establish a relationship with a qualified planner. Discuss what you want to accomplish. Discuss your goals, objectives, fears, tolerance for risk, attitudes towards money and all the qualitative factors that make “personal finance, usually more personal than finance”, as prominent financial planner, thinker and writer, Tim Mauer says. The relationship with a qualified planner should begin by you doing most of the talking. If you get to the end of the conversation and you don’t feel like you’ve even touched on any of the topics above, keep moving. There are good planners out there who will take the time to ask question and are truly looking to help.
- The planner should then collect all the data around your financial situation (assets, income, expenses, liabilities, etc…). This process should collaborative and comprehensive. If the planner is skipping over certain areas, and doesn’t seem concerned about the accuracy of your data, you know the drill, keep moving. A financial plan is only as good as the accuracy of the data collected.
- The planner then analyzes the data and creates and merges it with your stated goals and objectives. Here’s where the rubber meets the road. Thorough analysis happens at this stage and it’s where real strides are taking place. The planner begins to get a picture of how things currently stand, against what your stated goals & objectives are.
- Then, and only then, a customized plan should be developed together, with your family and your planner. The financial/retirement plan should address :
- Where you are today and set a course to walk you to where you want to be.
- Your goals and clearly identify risks.
- It may also include implementing solutions to get you to your goals and manage risks.
All these items together, should help determine your Personal Benchmark, which is the rate of return that you and your family need to achieve your goals. It’s different for everyone and is very important. Forget the S&P 500, Dow Jones Industrial Average, and Russell 2000, the only index or benchmark that matters is your Personal Benchmark; everything else is noise. An important note here, is that if you have sufficient assets to cover your goals, and there is a buffer in there, it may be determined that no additional return is necessary. Now, there are caveats up and down this scenario that need to be addressed, like inflation, etc… but the point is that everyone is different and everyone deserves to have a plan fit around THEIR goals, not a conflicted objective of the planner.
3 Retirement Risks to Consider
Generally, there are more than 3 risks to consider before and during retirement, however, these 3 risks are big ones and worth mentioning alone. These risks, and others, deserve to be addressed and well planned for before retirement and re-addressed during retirement.
- Longevity Risk: The risk that you’ll live too long.
Sounds a bit morbid, I know, but planning for this risk sure outweighs the alternative…running out of money and moving in with your children. Unless of course, you’ve planned on moving in with the kids as a way to spend more time with them, which is great. Either way this risk is real and with advances in medicine, it is becoming an ever-increasing risk which demands creative planning.
- Spending Risk: The risk that you’ll spend too much.
A portfolio withdrawal “rule of thumb” lists 4% as a safe withdrawal amount. This means that withdrawing 4% from your well-diversified portfolio per year should result in a favorable outcome. Taking more than this, has generally lead to consuming principal and an increased risk of running out of money. Recent research has hinted that given our current low interest rate and high value stock market environment, a 3% withdrawal rate is more statistically realistic.
- Sequence of Returns Risk
This final risk can be described in an example. Let’s say you hold a well-diversified, 60/40 portfolio (60% stocks, 40% bonds). We experience another financial crisis of 2007-09’and this portfolio is down 30%. You are taking withdrawals from the account to fund your retirement. We’ve all heard, buy low-sell high. Now, with the market down 30%, you’re forced to sell at a loss to create the cash to withdraw to live on.
Continuing this pattern of selling low and locking in losses creates massive risks over time. Managing this risk involves being creative and having a defined strategy before it happens. Often, managing this risk involves other pools of assets not directly “in the markets,” that are available to withdraw from during down markets. One strategy to potentially thwart this risk, is to use a bucket approach. Meaning, you keep enough cash in bucket 1 to cover short-term income needs (1-2 years’ worth). So, you know that whatever happens in the markets, you know you have at least 1-2 years of income sitting in cash to withdraw from. Of course, the downside is the opportunity cost of those dollars sitting in cash, not earning a return. Nonetheless, this plan isn’t for everyone and deserves a look, especially when you emotionally have trouble withdrawing form a portfolio during down markets. After this short-term bucket, come the medium-term and long-term. There are variations of what types of assets and investments should be held in these buckets, and it should be designed around you. In short, here’s where a little more “market fluctuation” typically happens. Again, because short-term income is taken care of, and longer-term growth may be necessary.
In all, it’s probably fine if you want to actually swim naked in or near retirement, I’m not going to judge. But don’t do it WITH your retirement, whatever retirement looks like for you. You only get one shot at it so might as well plan for it, regardless of what stage you’re in or how little planning you’ve done in the past.
Contact a qualified financial planner to help you with this process and help identify risks. Make sure they listen and design your plan around YOUR goals. Merchants Financial Advisors take this approach and are happy to help you chart the best course to help you reach your personal retirement goals fully clothed and aware of the falling tides.
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