How This One Mistake May Cause a Great Saver to Run out of Money in RetirementSubmitted by Reby Advisors on January 5th, 2018
How one woman invested her modest inheritance, let it grow until it was “enough to live on” for the rest of her life, and then made a common portfolio mistake that may prevent her from generating the income she needs to enjoy retirement.
The goal of this article is to take you through the process a CFP® professional would use to help “Roz” avoid this mistake and clarify a better investment strategy to support her lifestyle through retirement.
Meet Roz Warren, a 62-year-old part-time librarian and freelance writer who has decided she’s had enough of the stock market…forever.
In her recent Money Magazine article, she discusses her 30-plus year journey of investing for retirement and why she’s so emotionally relieved to be out of the market today. She explains:
“The Dow Jones Industrial Average could zip up to 30,000. Or it could crash and burn tomorrow. Not my problem. That part of my life is over. I’ll never again experience the elation of a market that is rocketing into the stratosphere. Or that sick feeling you get as the market is “correcting” and your net worth is circling the drain. All done.”
Roz inherited $50,000 in the early 1980’s, invested all of it in a low-cost Vanguard 60/40 balanced index fund, and then…did nothing for 30 years. She just let it grow…from a modest investment to what she describes as “enough money to live on for the rest of my life with absolutely no concern about what the market is up to.”
After a successful 30-year ride to riches, she’s out. For good.
At this point you may be wondering how much Roz considers “enough” for her to live on for the rest of her life?
More importantly - is it truly enough?
Or will her low-risk strategy - driven by fear of a stock market crash - actually cause her to run out of money, essentially guaranteeing the result she was trying to avoid when she decided to get out of the market?
First, Does She Have Enough Money to Get Out of the Stock Market?
My personal knowledge of her situation is limited to the Money Magazine article, but the article did give us enough information to figure out a ballpark estimate of what her $50,000 is worth today. Roz described her nest egg as:
“So how much money have I got? I’m not exactly a millionaire. But I do have a nest egg in the high six figures, a modest home with no mortgage, and zero debt.”
We also know that the Vanguard 60/40 Balanced Index Fund generated average annual returns of 8.19%, since 1983. Based on this, her account is probably worth right around $782,000 today. Amazing how the power of compound interest combined with prudent investor behavior works.
Give Roz the credit she’s due…through three market crashes and dozens of nerve-wracking “corrections” over 30 years, she never panicked and sold.
(Applause for staying the course for all those years).
We advise plenty of clients who retire with this level of wealth (or even less), so the total dollar amount of $782,000 isn’t necessarily concerning.
However, the question of whether someone has “enough” is subjective. To answer this question for Roz, we would first clarify and quantify her lifestyle goals, then determine whether she’ll have the cashflow to fund those goals without any investments in the stock market.
To run this analysis, we’ll use the information presented in the article and also make a few assumptions (because the article doesn’t cover everything we’d ask in an initial appointment).
Here's an excerpt about she had to say:
“I plan to continue to work at my local public library and write essays. Which is to say that I’ll continue to do the work I love, which provides me with a small but steady income…The stock market has been very good to me. Without money in the market, there’s no way that this part-time library worker and freelance writer would now have enough money to live on into her 90s. But, as the song goes, you’ve got to know when to hold them and know when to fold them.”
A few assumptions we made to run our analysis:
- She currently earns $55,664 per year - the average salary of a full-time librarian in Pennsylvania - and she’ll want to sustain her current lifestyle through retirement.
- She retires at age 70.
- She claims Social Security at age 70 (what we advise ALL clients to strongly consider).
- She will live into her early nineties (always plan, financially, for a long life).
- She’d has “multiple grandchildren” and would like to pay for their college education. We’ll estimate the cost of college tuition at $24,000 per year for two grandkids.
- Based on her new portfolio allocation (we’ll assume she invested in bonds, TIPS, and CDs equally), her expected average annual returns will be 3.04%.
Considering all of this, is $782,000 enough for her to live on for the rest of her life PLUS her stated goal of paying college tuition for “multiple” grandchildren?
Long story short: Most likely not.
With these assumptions, our MoneyGuide Pro financial planning software gives Roz a 0% Probability of Success (“success” is defined as funding all of your goals.).
The software runs 1,000 different economic scenarios that are beyond our control – for example, a stock market crash early in retirement – and Roz ran out of money in all of them. So she got out of the market to avoid ever going broke, but that’s exactly what happened anyway.
What Was Her Critical Retirement Planning Mistake?
What Roz chose to do with her money after growing her investment from $50K to nearly $800K is the decision that may ultimately derail her lifestyle. She explained:
“Now all my money is stashed in U.S. Treasuries, Treasury Inflation-Protected Securities (or TIPS bonds), and laddered CD’s, which, in the years to come, I can count on to earn me essentially nada.”
After factoring in inflation of 2.5%, taxes, and investment fees, her real return (what she brings home) from that fixed-income portfolio will be negative. In other words, her present allocation loses her money because her income will not keep pace with rising prices and taxes for the next 30 years. Remember, she’s only 62 today.
If your hard-earned retirement savings can’t keep up with those inevitable real-life forces, you better have a boatload of money (millions) in that retirement account or you better keep your spending very, very low because you’ll be withdrawing from your original principal just to live your lifestyle.
This is the “fallacy of safety” of an all fixed-income portfolio.
What She Can Do to Improve Her Probability of Retirement Success
Here are a few tweaks a financial planner may recommend:
- Fund only 25-50% of her grandchildren’s education – still a great gift for them and a much better outcome for her. I can’t imagine Roz’s children or grandchildren wanting her to run out of money due to her own generosity.
- Find ways to cut back on expenses or save more. This is easier said than done but nonetheless, it’s still an option.
- Reallocate her 100% bond portfolio into a risk-responsible, but slightly more aggressive allocation that is expected to beat inflation and rising taxes.
A combination of all three of these would get her somewhere in the realm of an 84% probability of success!
This is just a small glimpse into the value of goals-based financial planning and getting professional advice.
Plan Your Retirement Income the Right Way
A single hour-long conversation with a CERTIFIED FINANCIAL PLANNER™ professional may have helped her see a different perspective and approach to addressing the risk of a market crash. Over the course of a few additional conversations, she’d have a better plan with a higher probability of funding her lifestyle and her goals. An experienced CFP® would explain in plain English the recommended strategy and the reasoning behind it, listen to any objections, and collaborate with the client until they reached a plan she felt confident in and gave her a high probability of success.
Do you or someone you know need a retirement income plan? If you’d like to minimize the risk of running out of money in retirement, follow the link below to request a complimentary retirement income plan from Reby Advisors.
This article is for educational purposes only and should not be considered as tax, legal, or investment advice. Each individual's situation is different. This article should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.