What do the Rolling Stones have to do with retirement planning?
Was Mick Jagger an accidental financial genius?
Because I’m about one step from tone deaf, I’ve never really become a music aficionado, but I do appreciate popular songs that tell a good story. I’ve always liked the line in the Rolling Stones classic, “You can’t always get what you want; but if you try sometimes, you just might find; you get what you need.” While the Stones probably didn’t intend this, those lyrics summarize an important philosophy when planning a retirement income strategy.
Many people want to be able to get through retirement without touching the principal of their investments, but in the meantime, they need to pay their ongoing bills. The result is that many investors try to maximize the interest and dividends that their investments can generate and then try to maintain that level of income year after year without touching principal.
The problem with this income-based approach is that nobody has ever devised a way to predict the gyrations of interest rates and financial markets. The result is frequently an unbalanced portfolio that is too concentrated in certain types of investments. Furthermore, if interest or dividend rates decline, you could find yourself dipping into principal at an inopportune time in the business cycle. Inflation will probably force you to increase your spending levels and you will almost certainly need to withdraw principal.
Make a spending plan, not an income plan
Fenway Financial Advisors recommends a different approach by figuring out how much you need each year and then constructing a retirement spending plan coupled with an investment plan designed to reasonably meet those needs over time. There is growing agreement in the financial community that a more appropriate approach to establishing a retirement income level is to start with a formula comprised of annual social security, pensions, other income (annuities, rents etc.) plus a maximum of 4% of total retirement savings.
While these figures are highly dependent on each investor’s current age and longevity and of course the performance of the financial markets, push this withdrawal rate up even just a little to 5% and an individual may need to dip heavily into principal at some time during retirement. Bump the withdrawal rate to 6% or higher and it substantially increases the likelihood that an investor may outlive her assets.
Keep in mind that annual expenses include advisor fees and taxes. The typical 1% fee many financial advisors charge significantly reduces the advantages of compound interest for pre-retirees and these fees reduce income dollar for dollar for retired clients. If an investor has $500,000 in retirement assets and withdraws 4% annually ($20,000), she will have less than $15,000 left to safely spend from her investments after paying $5000 in advisory fees and taxes. This is why Fenway Financial Advisors recommends paying reasonable and transparent hourly and fixed fees for financial advice. While we are fairly compensated for our services, we recognize that you should be funding your retirement, not ours!
Time horizon is key
Because we don’t have a crystal ball, Fenway Financial Advisors recommends a long-term approach that first determines each investor’s retirement spending needs. From there, we invest in an appropriate mix of cash, bonds, stocks and other investments matching the timing of those cash needs.
For example, depending on a hypothetical investor’s age and tolerance for the volatility of the financial markets, money that is required in the first year of retirement might be placed half in a money market and half in a six-month CD. Funds needed over the next one to three years may be invested in CD’s or other relatively secure investments to allow the client to sleep comfortably through the daily turmoil of the financial markets. Planned expenses in years three to eight would be invested in an appropriate portfolio of bonds and the remainder would be invested in a mix of domestic and international stocks with small amounts in other appropriate investments like real estate that historically have moved independently of the stock and bond markets.
Typically once or twice a year, interest, dividends and capital gains are repositioned to maintain this balance so that ongoing expenses are covered and the client still has a reasonable expectation that her assets will grow sufficiently to last throughout retirement, possibly with a tidy sum left over for children, a favorite charity or other beneficiary.
Best of all, while we agree that you can’t always get what you want, when the market does have an exceptionally good year, sometimes you can treat yourself to a reasonable bonus.
If you need a spending-based retirement plan, please give us a call at 617-948-2102. We’re confident that you just might find that you will get what you want.