PART 2: HOW MUCH YOU NEED TO RETIRE

Developing financial projections during the retirement years is very similar to the ones we covered last week during the working years. The only differences are:

• You need to substitute annual withdrawals (your annual spending) for deposits (your contributions during your working years).

• You need a solid cash management strategy to support those withdrawals.

Note: There are tax considerations that need to be taken into account during retirement, but we are not going to cover those today. You should consult either your accountant or a financial advisor to address taxes in retirement.

WHAT YOU’LL NEED:

• Beginning retirement accounts balances at age 65 or the age at which you retire.

• Estimated amount of money needed to withdraw each year to support your living expenses.

• Your investing strategy and expected annual returns.

• A cash management strategy.

Beginning balance

Your beginning account balance is simply your ending account balance from the projections we discussed last week. If you plan on retiring at age 65, for example, this would be the projected or actual account balance at the end of your working years at age 65.

Annual withdrawals

During your working years you were making annual contributions to your retirement accounts. During your retirement years you will probably not be making more contributions to your retirement accounts. So rather than adding in your annual contributions to your spreadsheet projections, you will be deducting your annual withdrawals.

We will be keeping things simple today, but this step can require a lot of detailed calculations. Some people make detailed projections of their monthly living expenses in retirement. This is fine if you want to take the time to do it.

Most people have lower monthly expenses in retirement than they incurred during their working years. Housing expenses are often lower in retirement as most people have paid off their mortgages by the time they retire. Many people also downsize their living space which can lead to lower expenses in retirement. Health insurance premiums are also typically lower in retirement due to switching over to Medicare.

Cost inflation is an important consideration for your retirement projections. While your monthly expenses may start out lower in your mid-sixties, your expenses will continue to rise during your retirement years.

A fairly simple way to handle your spending needs in retirement is to use your monthly living expenses before you retire. For example, if your monthly living expenses are around $8,000 per month before you retire, you could use this amount as your annual after-tax withdrawal amount. A $96,000 (8K time 12) annual spending level would correspond roughly with a 30% tax rate. At a 30% tax rate, you would need to withdraw $137,000 per year to cover taxes and the $96,000 in annual spending.

If you are close to retirement age, it might make sense to do more detailed calculations of your living expenses in retirement. If you are a long way off from retirement (10 years or more), I would recommend a simpler approach.

Investment strategy

Your investment strategy and approach take on even greater importance in retirement. During your working years, you can make up for a poor investment strategy with higher annual contributions to your retirement account. You won’t be able to do this in retirement. Everything depends on your investment strategy.

The lack of contributions and having fewer years to recoup losses causes people to become even more conservative with their investment strategy during retirement. This is totally understandable, but it could lead to running out of money during retirement. Working longer is the only way to avoid this.

The average investor makes only about 4% to 5% per year in their retirement accounts during their working years because they invest too conservatively. Following a similar approach in retirement leads to average annual returns of 3% to 4% per year due to the need to keep an even higher amount of funds in cash.

A lot of 401K investors follow industry best practices and earn a little over 7% per year during their working years by investing in target date funds. Following this approach in retirement leads to average annual returns or around 5.5% to 6% per year due to the need to be even more conservative in retirement.

Earning only 4% to 6% in retirement severely limits spending and wealth creation during the retirement years. But until the last five years, investors had no other good options.

Our clients that subscribe to Market Signals earn at least twice these returns during retirement. It often leads to millions of dollars more available to spend in retirement. It often is the difference between working into your seventies or living very comfortably and without any worries in retirement.

Cash management strategy

A core best practice in money management is to never withdraw money from an investment account at a loss. This is true in your working years and in your retirement years. If you do not have a good cash management strategy in place during retirement, you may be faced with this unfortunate situation.

The way to avoid this situation is to move profitable investment funds (current value is above the purchase price) to safe cash accounts before you need to withdraw the funds. Average investors that are very conservative already have their funds in lower risk assets like cash and bonds. These conservative investors do need to be careful with bond investments, however, since they can and do lose money.

If people had money in bonds at the end of 2021, the price of those bonds may still be 20% lower today and they may take several years to recover. If the bonds you hold have terms of five years or less, you would want to start transferring those bonds to cash accounts three to five years before you need to withdraw the money. Long term bonds would require you to make the transfers even earlier.

Retirement funds that are invested in stocks have even greater risk of losing money which may force you to sell the stocks at a loss when you need to withdraw money during retirement. For this reason, it is recommended that retirement investors move their stock investments to safer cash accounts at least seven years before the need to withdraw the money. From our earlier example of a person needing to withdraw $137,000 per year in retirement and if that person had all of their money in stocks, they would need to start moving $137,000 per year to cash at age 58 (seven years before retiring at age 65).

This is another significant advantage for our Market Signals subscribers. Because our investment system is designed to avoid the big losses that happened during stock market crashes, they only need to begin moving money to cash two or three years before the time they need to withdraw the funds. This alone provides a significant investment performance gain during the retirement years.

Managing all these considerations properly during retirement will lead to a much more successful retirement. You deserve a more secure and more comfortable retirement. You need to get this right.

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Happy Investing,

Phil

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Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.