The five years before retirement and the five years post-retirement is often called the dangerous decade - missteps during this time have long-lasting effects. What do you really need to know as you prepare for retirement?
- How much money do you need? Consider all your financial resources including retirement plans, investments, and Social Security. In order to calculate the amount of money required, you need a realistic summary of your annual expenses. Some expenses will drop off after retirement but not to the extent you think.
Some clients are convinced their spending will go down substantially after retirement. We have significant empirical data that tells a different story. Assuming good health, our evidence suggests spending will change relatively little in the first few years of retirement. For planning purposes, 80% of pre-retirement spending, adjusted each year for inflation, is a reasonable place to begin. Assume that you can withdraw no more than 4.5% per year from your investments to meet expenses. It’s also important to realize that you will need to make course corrections at regular intervals to reflect actual withdrawals and investment earnings.
- How much do you need to save to close the gap? If you don’t have enough financial resources accumulated, you need to know how much you should save each year prior to fully retiring. This may be the point where the number of years you need to save comes into sharper focus. If you want to retire in five years, but need 10 years of savings, you obviously need to know that well in advance.
Those are the “hard dollars, hard choices” you will confront as you transition from working and saving, to not working and withdrawing from your savings.
- What type of financial behavior do you need? Since you will need to offset cost of living increases, you likely will need a significant ongoing portfolio allocation to risky assets like stocks. Your ability to stay invested in both good and bad conditions will greatly influence your money life. The actions you take--how you behave, is critical to your long-term financial success.
Of course, there’s sometimes significant tension between the various aspects of your money life. The wrong behavior impacts how large the gap is between your current position and where you want to be. Your lifestyle spending directly affects how much financial capital you need to compile.
- What does the life you want look like? You will need money for that of course--but don’t chase the elusive "more" - find your enough. Money can help buy happiness if done well, but it’s disastrous if you believe that you never have enough. Don’t try to always maximize and optimize--choose to live your life instead.
True happiness, from a financial perspective, is not having to think about money. Money is a tool, a technology that you can put to good use. It should improve your life, but not dominate your life. Start there. Ready for a real conversation?