Know Your When

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The Second Step to a Happy Retirement

Knowing when you will start to spend your wealth is a critical element of the steps needed to transition to your Happy Retirement. This is because of your exposure to investment losses as well as losing focus on what your assets are for.

In our last post, we looked at knowing your why. If you are saving and investing to just see your wealth grow, then having portfolio volatility is no big deal as long as the assets appreciate in the long term.

This is only possible if you will never be spending any of the money in the portfolio!

What’s at Risk with Your Retirement Savings

The most common risk measurements are based on models that assume you will not be spending your assets. They focus on the risk of loss and time to recover from those losses. This is how institutional investors measure risk.

The difference from them and us is that they are looking to have their money grow forever (think mutual funds, pension funds, private equity, endowments, etc). There is no “end” time for the portfolio.

In our personal financial life, there is an end time, we will all face, and as the movie once said, “you can’t take it with you”.

This view of risk and “risk tolerance” are fine if you have decades to go before spending your wealth. After all, you are paying your bills from your work income and your savings and investments are intended to grow until needed to provide security in retirement and replace your paycheck.

What is the Difference, Why Should I Care?

Once you enter the retirement glide path and you can see the time you will spending your savings and investments, the risk becomes losing money. Some years ago, Prudential published a white paper on the subject. The reason not losing money in the 5 years prior to and the 5 years after retiring, is the amount of time it takes to recover.

Once you start spending your invested money and discontinue or greatly reduce your paycheck, that spending doesn’t stop. You still need to pay bills, keep the lights on and fill the refrigerator. This could force you to sell investments when their value is down, reducing the assets you have that can participate in a recovery. This greatly accelerates the pace at which you are spending down your assets. I think of it as “reverse dollar cost averaging”.

What is Dollar Cost Averaging?

You may have heard of “dollar cost averaging”. This is when you make regular investments based on time (like monthly) and not price (buy low, sell high). The logic is that this forces you to buy when things are bleak, and you are afraid to invest. This will tend to reduce your average cost of an investment.

In reverse dollar cost averaging, you are forced to sell when the market is low, which will reduce your average price for selling those same assets, which means you will run out of money sooner.

How Does Dollar Cost Averaging Work?

For example: You own 1,000 shares of XYZ stock. You need to have $2,000 in monthly income and the share price fluctuates between $100 and $200 each month. So to get the income in month 1, you would need to cash in 20 shares, but if it went to $200 in month 2, you would only need to cash in 10 shares. In month 3, the price is back at $100, so you would need to cash 20 shares and so on.

By having to cash in more shares when the price is down, you would be reducing the number of shares that could participate in the return trip to $200. This accelerates the rate at which you spend down the account dramatically!

This risk is also referred to as “sequence of return risk”. We have a spreadsheet in the office, which I am happy to share with you, that takes the last 21 years of returns for the S&P 500 plugged in. You can put in the amount of your portfolio and then we have a button that randomizes those returns into a different order. It is quite eye opening to see the wide variety of outcomes in terms of total value of the account. By adding in a withdrawal to the calculation, you can see that the difference between having your money last through your retirement and not, is dramatic when we change the order of returns for the index. The difference in how long your money lasts can be decades!

Retirement Really is Different

I have said many times how different the retirement time of life is. It is the first time you have complete control over what you do and when you do it. This is a huge change for most people.

That is why I encourage clients to consider what they want to be doing with their life in retirement.

Whether it is a bucket list of experiences, giving back to the community, starting a business, getting a degree, or just hanging out with friends and family, this time is truly your own.

In order to enjoy control over this time, you need to have a plan to replace your income and pay for your lifestyle. While you are planning your investment strategy to allow your money to last a lifetime, while living your retirement dreams, keep “when” you will be making the transition to your Happy Retirement. That way you can enjoy the golden years on your own terms.
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