Calculating the Real Cost of Retirement

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Without question, retirement requires a certain mindset. Though we would love to plan for an extended period of health and prosperity, responsible planning demands that certain “what-if” assumptions should be considered.  Not understanding how things like lifespan and interest rates work together has cost more than one person their retirement happiness.

A UBS Wealth Management Survey asked 2,000 investors, mostly over the age of 50 and with $1 million or more in investable assets, about their retirement thinking. Last week, Walter Updegrave’s Time article “3 Tips from the Very Rich That Can Help You Improve Your Retirement”, referenced the UBS  survey and did a fine job of highlighting a major misconception about retirement. Successful retirement isn’t about replacing your income but rather replacing the income required to maintain your standard of living. Many articles advise saving to replace a percentage of annual income, but that is a bad strategy in my experience. Instead, investors should focus on funding a revenue stream to maintain their standard of living.

Where Mr. Updegrave and indeed the affluent folks surveyed go a little astray is that the measurement of retirement readiness is driven by a calculator filled with assumptions. You may think that a 1-2% differential in assumptions is irrelevant but the typical retirement for a married couple age 60 (according to actuaries) can last three decades. An assumed need of $2,500 for monthly income in year one will require $4,528 of monthly income 30 years later, assuming a 2% inflation rate. A 3.5% inflation rate will demand more than $7,000 a month in three decades!

Retired investors today will tell you the difference between the yields on their old 5% and 6% CDs versus the 1.5% or less yields on CDs marketed today. When you use retirement calculators do you enter the rates from the 80s, the 2000s or 2017? You must start somewhere and you also must consider the impact of your assumptions regarding future economic environments. If you assume low investment returns and high inflation, you might be ahead of the game. But you may also be leaving a lot of life on the table. As a new financial professional 29 years ago, I used the formulas that I learned as a CFP and followed the assumptions above. Academically, the formula made sense. Today I have a lot of families in their 80s and 90s with a lot of money left and not a lot of life remaining.

Today, we employ a different retirement strategy that involves a practice year to prepare the mind and the budget for a fixed income. We break the budget down into fixed expenses that will continue and social expenses that tend to decline as people age. The national average says social spending starts to drop at age 65, although my practice finds age 68 is when social spending begins to decline. At that point, we look to three-year blocks of time to smooth out the market and interest rate volatility.

When planning for retirement, assume with care.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column offset=”vc_hidden-lg vc_hidden-md vc_hidden-sm”][vc_widget_sidebar sidebar_id=”sidebar-main”][/vc_column][/vc_row]

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