What Can the Retirement CARE Analysis™ Tell You About Your Retirement Plan?
A natural guideline for the retirement spending decision is to first determine what spending rate would satisfy your overall lifestyle goals. Beyond that, you need to consider the following:
- Your degree of spending flexibility to make cuts if necessary,
- Your general view about whether your spending may need to keep pace with overall consumer price inflation, and
- Whether you want to maintain a safety margin for assets.
Armed with this information, you can then consider the broad range of variable spending strategies and choose the one that seems to best match your goals and manage your risks. My research in this area seeks to develop a framework to help with the decision-making process.
How should a retiree choose a spending method and parameterize the initial spending rate? I have provided a framework to think about the important issues, such as spending flexibility, feelings about upside spending growth vs. downside spending risks, the possibility of a minimum spending threshold to be protected, the desired direction of spending (for instance, whether to decrease spending over time), the appropriate planning horizon, and any legacy goals.
A broader set of issues to consider when deciding on a withdrawal rate and asset allocation relate to a Retirement CARE Analysis™. Answers to the following questions will help guide these decisions:
- Do you have sufficient retirement income from reliable sources that will not be diminished by market downturns?
- How would you adjust your lifestyle if you had to spend less? Is your answer reasonable?
- Are your portfolio distributions flexible enough that you could reduce them after a market downturn without adversely affecting your standard of living in retirement (either because it is easy to make simple lifestyle changes or you have sufficient reliable income sources like pensions and annuities available outside your portfolio)?
- Do you have insurance to protect from dramatic spending shocks related to health, long-term care, or an unexpected death?
- Related to your funded status, do you have reserve assets that could be deployed to cover spending after a market downturn (that are not earmarked to meet retirement spending goals)? Is the value of these assets correlated with the stock market?
- What are your retirement spending goals? How are they divided between basic and discretionary expenses?
- Do you expect your lifestyle spending goals to keep pace with inflation? Are your spending needs sensitive to inflation?
- How long do you want your money to last?
- Do you want to build in a margin of safety for remaining assets?
- What are your legacy objectives?
- What are reasonable expectations for different asset classes during retirement?
- How much short-term market volatility can you stomach before it starts affecting your sleep with undue stress or causes you to panic and sell stocks after a market downturn?
- What is your longevity risk aversion? How worried are you about outliving your assets? How strongly do you wish to avoid spending reductions in the event you live well beyond your life expectancy?
- Can you stick to the spending and investment objectives for your financial plan without being strongly tempted to overdo things or arbitrarily change course?
- Are you vulnerable to making other behavioral mistakes that could harm the long-term prospects for your financial plan?
- How complex is the financial plan? Can it run on autopilot or be facilitated by a trusted financial professional, or does it require ongoing complex decision-making on your part?
- How financially savvy are different members of your household? Would surviving household members be able to carry on financially if you were incapacitated due to illness or death?
In answering these Retirement CARE questions, a more conservative retiree will experience some of the following characteristics:
- Fewer reliable income sources outside of the investment portfolio to help cushion the impact of market volatility on lifestyle,
- Lower flexibility to make spending reductions because spending goals are fixed and adjust with inflation,
- Fewer reserves, buffer assets, or insurance policies to help cushion spending shocks,
- A greater desire to build in a margin of safety for the financial plan,
- Greater worry and stress about short-term market volatility, and
- Greater worry and stress about outliving your retirement assets.
Meanwhile, a more aggressive retiree will tend to fall in the opposite direction on these matters, highlighting the highly personal and complex nature of determining asset allocation for retirement.