A version of this writing appears in MarketWatch.
The recent downturn in the stock market has placed an important decision on the back burner.
It’s not strange to change direction through a storm of uncertainty. Through a volatile period it’s not unusual to move a retirement date out, continue to collect a paycheck, bolster savings and reduce debts.
I hear it often – “I’ll work just one more year.”
On the surface, it feels right to wait.
I call it ‘failure to launch.’
There’s never an opportune time to retire, regardless of the preparation and the formal financial planning undertaken to ensure lift-off. Frankly, even when the stock market is on solid footing people tend to find reasons to delay the next step.
It’s perfectly understandable. It’s human to feel vulnerable at the crossroad of a life-changing moment especially when the moment has arrived.
The financial planning process can inadvertently exacerbate “launch dysfunction.” It’s also in a planner’s nature to be conservative and advocate a decision to wait for a better time (whenever that is).
I’ve discovered after hundreds of retirement discussions and volumes of plans delivered, that the decision to wait is rooted in an overdependence on the successful outcomes of formal retirement plans designed to predict the survivability of assets to meet lifestyle expenses for three decades or longer.
But is that practical?
Before you decide to undergo retirement planning, you must make peace with the fact that the entire process is extraordinarily imperfect, like you and me.
Retirement plans are 20% science and 80% forecast (or art).
Unfortunately, there are elements you will never be able to predict with complete accuracy. You may not live to 95 even though you believe it to be true. Future market returns are an educated guess at best.
Instead of waiting for every financial star to align before retirement, consider the following random thoughts:
You’re better off with formal retirement planning, than not. People who begin formal planning early on, five to ten years before retirement, increase the odds of a successful launch date compared to those who begin late or not at all.
A plan which includes a complete inventory of assets, liabilities and future goals coupled with assumptions for inflation and realistic future investment return simulations helps you gain invaluable intelligence early that can be used to create an ongoing action plan to validate positive financial habits and minimize the impact of weaknesses.
A plan is not right or wrong, successful or unsuccessful. It’s not a threat, or a reason to be chastised for poor fiscal behavior. The first iteration is the start of a long-term educational process, an awareness and ongoing tuning of financial strengths that apex at a launch point I call ‘escape velocity.’
Consider escape velocity a financial trajectory that launches a retiree successfully through the first decade of expenses and withdrawals with minimal negative impact to investment assets. Academic studies outline how the first ten years of asset drawdowns is crucial to the survival of a portfolio over the next twenty.
Within a plan, your financial life is run through a simulation to determine probabilities of success which comes down to your money lasting as long as you do (or longer if you wish to leave assets behind for others).
You’ll see, how in the face of withdrawals and changing market returns, your asset values ebb and flow. Through great bull markets (best case), bear markets (worst case hope not) and somewhere in between.
If your assets can make it through the first ten years successfully. And I mean at a 75% or greater probability of success, you are ready to launch into imperfect retirement mode as long as expenses are monitored annually and changes are made to reduce lifestyle expenses.
I’m not saying it’ll be clear sailing. Or you won’t need to adjust mid-flight: Work part-time, cut costs, downsize.
Most likely, you will.
I’m saying there’s a delicate balance at stake. A point of no return to consider.
Either retire early enough to enjoy the experience, forsake a perfect planning outcome, take a leap of faith, or wait until your probabilities of success through the worst market cycle is 95% or greater. By then it may be too late due to health issues and aging. The retirement you hoped for may be one you regret.
You see, this is the art part. When you’re planning to travel a path three decades long, science fades into the dark pitch of road and creativity and faith take over, more often than not.
Mentally, you must let go of perfection and consider multiple detours to navigate the imperfect.
Be overly (insanely) cautious the first five years. Academic work by financial planner, speaker and educator Michael Kitces and Professor Wade Pfau outlines how your asset allocation should be conservative in the early stages of retirement, especially in the face of lofty stock valuations.
Generally, I have retirees reduce equity exposure by 20% at the beginning of retirement and I’m not opposed to holding 2-5 years’ worth of cash or cash equivalents for withdrawals and to eventually purchase stocks at lower prices.
You’re thinking cash doesn’t earn anything. Well, it doesn’t lose anything, either. You can make up losses due to inflation. Principal erosion due to market losses is an entirely different story.
What most investors do not realize currently is that they could hold cash today and in five years will likely be better off. However, since making such a suggestion is strictly “taboo” because one might “miss some upside,” it becomes extremely important for measures to be put into place to protect investment capital from downturns.
Friend and business partner Lance Roberts provides the following chart which outlines the inflation adjusted return of $100 invested in the S&P 500 (using data provided by Dr. Robert Shiller).
The chart also shows Dr. Shiller’s CAPE ratio. We capped the CAPE ratio at 23x earnings which has historically been the peak of secular bull markets in the past. Lastly, we calculated a simple cash/stock switching model which buys stocks at a CAPE ratio of 6x or less and moves to cash at a ratio of 23x.
The value of holding cash has been adjusted for the annual inflation rate which is why during the sharp rise in inflation in the 1970’s there is a downward slope in the value of cash.
However, while the value of cash is adjusted for purchasing power in terms of acquiring goods or services in the future, the impact of inflation on cash as an asset with respect to reinvestment may be different since asset prices are negatively impacted by spiking inflation. In such an event, cash gains purchasing power parity in the future if assets prices fall more than inflation rises.
The importance of “cash” as an asset class is revealed.
While the cash did lose relative purchasing power, due to inflation, the benefits of having capital to invest at low valuations produced substantial outperformance over waiting for previously destroyed investment capital to recover.
While we can debate over methodologies, allocations, etc., the point here is that “time frames” are crucial in the discussion of cash as an asset class. If an individual is “literally” burying cash in their backyard, then the discussion of loss of purchasing power is appropriate. However, if the holding of cash is a “tactical” holding to avoid short-term destruction of capital, then the protection afforded outweighs the loss of purchasing power in the distant future.
Cash is not exciting. However, the excitement at the beginning of retirement should be about the memories you build, not the money you can potentially lose in stocks.
Cover as much fixed expenses as possible with income you can’t outlive. Maximizing Social Security payouts and minimizing taxes on those payments by coordinating benefits received with withdrawals from investment assets, can add thousands to your household cash flow over a lifetime.
Social Security is an income stream you can’t outlive and should not be discounted in your retirement analysis. It needs to be a crucial element of your written plan.
Creating a pension through the use of deferred income or single-premium annuities can supplement social security and bolster your income for life.
Investors fear annuities. Financial pundits on the radio and in print advise how annuities “are bad.” If you’re purchasing annuities, you’re most likely taking money away from them as advisors. Understand the motives behind negative blanket statements about annuities.
Not all annuities are the same.
Consider the word annuity means “a fixed sum of money paid to someone each year, typically for life.”
Social Security is an annuity, right?
The combination of Social Security plus income annuities can be employed to cover expenses you must pay – think rent, food and insurance. Leaving your variable assets like stocks as supplements to your income requirements.
Avoid variable annuities. They are unnecessary and expensive. When you think negatively about annuities, it’s the variable ones you’re most likely referencing.
Decrease cash outflow throughout retirement. The first two years of retirement is a soul-searching expedition. It’s also a period where I witness retirees highly sensitive to stress and anguish from having too much ‘stuff,’ large homes and big overhead.
Reducing financial pressure by going smaller generates great emotional benefits. Monetary bandwidth can be built into your budget. If you’re prepared to reduce portfolio withdrawal rates through rough market periods without seriously inhibiting your lifestyle, then an imperfect retirement mindset can work.
An imperfect retirement strategy is not “set it and forget it.”
Throughout, you must be willing to regularly meet with your financial partner to analyze withdrawals market cycles and adjust accordingly. In addition, you need to be receptive to change and flexibility. Even be open to part-time employment to increase household income.
Because waiting for perfection is not practical or realistic.
And a life is at stake.