Written by Hi, it’s Dre Griggs with Obsidian Wisdom. There are five main risks to a prosperous retirement we will discuss today. They are (1) longevity, (2) over/under spending, (3) timing/sequence of returns, (4) inflation and (5) healthcare expenses.
1. Longevity risk
Longevity is tied to outliving your money because you lived too long. This is only a problem because none of know when our time is up. If we did, we could calculate how much we can spend each day without any issues. The problem with not knowing how long we’ll live is we have to allocate our money in a way that it doesn’t run out. For many, this is following the 4% rule (or something similar). The idea is, if I only spend the interest my money generates each year, I should never run out of money. 4% was chosen as the number because most conversative retirement portfolios can generate 4% each year.
If you have $1,000,000 saved for retirement, 4% of that is $40,000. As long as your portfolio is generating $40,000 per year, your balance should remain the same. If for some reason you have an off-year. You live off 4% of your new balance. For example, if your $1,000,000 dropped to $800,000 – 4% of that is $32,000. Therefore, you would only spend $32,000 (instead of the $40,000) each year going forward. As you can see, it doesn’t take many down years before your retirement and retirement lifestyle are in jeopardy.
Avoiding longevity risk
We run what are called Monte Carlo simulations to create the best financial plan for you. Monte Carlo simulations are a fancy way of saying, we assume 1,000 different outcomes and measure how many times you don’t run out of money. The goal is to get above 80%. The other thing we like to do is create your financial plan assuming you make it 100 years old. The average life expectancy is currently 87, but if you plan for 100, you should be safe.
2. Overspending or underspending your money
That leads us into the second main risk to a prosperous retirement; which is overspending and underspending. You are probably not surprised about the overspending. Most people build their spending habits based on their income. When you worked, you could simply work more hours to get more money. When you retire, your income usually decreases. But, do does your ability to work for additional money.
Underspending is also an issue for many. If you spent your life saving, it is difficult to turn the switch to spending for some. There is always this fear of running out of money, so some retirees spend little to nothing. This may not feel like a problem immediately, but it can become one. Some people avoid going out, visiting with family or their healthcare provider. The fear of running out of money has them sitting at home waiting eating Ramon.
Shaking off your spending concerns
This is why the Wisdometric Framework focused on building passive income. The best way to overcome your spending problems is to replenish your income. Instead of solely living off the interest your investments earn, invest in assets that pay you each month. This could be rental income or recurring profits from a business. You can build royalty income from patents, inventions or intellectual property. The benefit of having reoccurring income is the comfort of knowing you will receive a check on a regular basis. Now, you still need to keep your spending under control, but you shouldn’t be worried about running out of money.
If you enjoy stocks investing, you can invest a portion of your money into dividends stocks. Dividends are a great way to build income over time. There is also the less risky approach of investing in an annuity. There are a variety of annuities. It’s important you know the fees, prepayment penalties, etc. Annuities are only offered by insurance companies. So you want to make sure you are committed to that strategy, as leaving can be difficult.
3. You just got unlucky
The third risk to a prosperous retirement is timing and sequence of returns. Sequence of returns is you happen to invest your money or retire right when the market starts losing money. As a result, you start with a loss and it significantly reduces your change of a successful retirement.
The reason is simple. If you had $100,000 invested and it lost 10% the first year, your account balance would be $90,000. If your investments gained 5% the following year, your balance would only be $99,000. In other words, you have to make back more than you lost to get back to your original number. This is a problem in retirement because your investments are more conservative and you’re spending your assets down. It is almost impossible for you to climb out of the whole to get your balance back to where it started.
Buying good luck
A common approach to help overcome a streak of bad luck is to use Dollar Cost Averaging (DCA). DCA is when you invest your money on a regular basis over time. You are not interested in investing all your money in one-lump sum. When you invest in one-lump sum, there is a change you will win and a chance you will lose. By investing the same amount over a period of years, you give yourself the opportunity to average out a stock price.
If you are retiring, you want to have income options that are not tied to the stock market. As a result, if you lose a large portion of your portfolio in the first year, you can use your other assets while your stock replenish. You have to get a multiple of that. So it ends up becoming more difficult to climb out of a hole. And that trajectory immediately changes how long your income was going to last in retirement. And so if you were worried about that, then it’s, it becomes a in your benefit to at least put the money in it’s called dollar cost averaging, where you basically spread the money out evenly.
4. Maintaining your purchasing power
Inflation is the fourth main risk to a prosperous retirement. The numbers show that about every 17 years, your purchasing power cuts in half. That means what cost you $100 today, will cost you $200 in 17 years. In other words, you will need twice as much money to live the exact same lifestyle you are living today.
Inflation tends to hover around 3% each year. There are years where it is much higher, but that averages out with the years that are much lower. When I was a kid, gas was about a dollar per gallon. Well, gas is about 500 times that right now. So if your retirement assets are not growing with inflation, you won’t be able to afford gas twenty years into your retirement.
Outperform inflation
To maintain your purchasing power and beat inflation, you need to invest your money in assets that give you a return higher than inflation. Therefore, if inflation is estimated to be around 3%, you must get at least a 3% return on your investments. That is why rental properties and the stock market are nice investments to beat inflation. The value of the companies in the stock market are based on current values. As a result, inflation is built into the stock market. Rent is adjustable, so your rental income can keep up with inflation as well.
5. Skyrocketing healthcare expenses
Our final main risk to a prosperous retirement is healthcare expenses. We spend more in healthcare as we get older. That has some to do with our health. It also has to do with the fact we don’t have an employer helping pay our healthcare costs. Ideally, you want to budget for long-term care events. On average, the numbers show someone can expect to spend $300,000-$400,000 on long-term care in retirement. If you don’t account for long-term care, it can cripple your retirement. Just one long-term care (LTC) event can wipe our your retirement.
Overcoming rising healthcare cost
You have two main choices. The first is you can budget for your long-term care. You have the number. All you need to do is increase your retirement amount by $400,000. If you have a long-term care event, you have the money to spend. If you don’t have any healthcare issues, you have a larger inheritance to leave behind. The other option is to purchase LTC insurance. LTC insurance takes some of the risk off of your plate and puts it on the insurance company. They will be on the hook for your LTC event, as long as you qualify and make your monthly payments. LTC insurance is a relatively new industry, so they are still working on the kinks. Make sure you choose a reputable company you know is going to be around for the next 100 years.
Final thoughts
You now know the five main risks to a prosperous retirement and how to solve them. The key to retirement is planning. If you have a plan in place, you have the time to prepare. Whether that is saving more money, changing your investments or qualifying for additional insurance. More options are available the sooner you start. If you wait until you are experiencing the five main risks to a prosperous retirement, it is probably too late. Until next time Wisdomites, remember, wisdom is asking the right questions to allow yourself to get the right answers. Keep asking those questions and you will keep getting those answers.
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