By Dennis Kagel, Chartered Financial Consultant
As the name implies, this type of retirement plan involves establishing the number-one priority to make absolutely certain that basic, essential needs will be covered in any market environment. We enjoy telling our clients, “Whether the market goes up, down, or sideways you will be OK.” Our clients find great comfort with this approach.
Essential needs are defined as monthly fixed expenses. Included would be gas, water, electricity, phone, cable, Internet, food, gas (vehicles), mortgage payments, and food (groceries/meals). Include homeowners and auto insurance, property taxes, vehicle maintenance, health insurance, vision and dental insurance, prescriptions, life, disability, and long-term care insurance. With this last group, determine average monthly amounts spent. For example, let’s say your property taxes are $2,700 each installment. You would record $450/month. Most of us are used to dealing with income and expenses monthly.
Give thought to how much is spent on clothing, haircuts, dry cleaning, and personal care items, such as toiletries, monthly.
The first step in a Safety-First Retirement Plan is to build a floor of guaranteed income to cover basic spending needs in retirement. The guaranteed income floor is built with a combination of Social Security, a defined-benefit pension, and your investable assets (401k, IRA’s, etc.). Pensions are going away, so it’s becoming important to know how to best utilize your personal retirement plans.
Avoid this mistake — dramatically increase odds for a successful retirement
Most fall into the “trap” of focusing on the total balance in their retirement account(s). This is natural to do, especially while we’re working and contributing to our plan(s), but the day you retire all the rules change! The total balance is no longer most important. What is now important is how much will your “pile of money” pay you per month and for how long? Stated again, the objective of investing in retirement is not to maximize returns, but first to ensure that basics will be covered in any market environment. Only then is it appropriate to invest for additional upside (risk). Volatile assets are suitable for discretionary expenses and legacy (leaving financial assets for family or charities). With these areas, there is usually some flexibility about whether the spending can be achieved.*
The general view of safety-first advocates is that there is no such thing as a safe withdrawal rate from a volatile portfolio. A truly safe withdrawal rate is unknown and unknowable because of variables such as life expectancy, rates of return in the future, and inflation.**
Retirees have little leeway for error. Going back to work might not be an option. Volatile assets like stocks, bonds, and mutual funds are not appropriate when seeking to meet basic retirement living expenses. Just because a strategy did not fail over a historical period, does not ensure it will always succeed in the future.*
Once a sufficient floor is in place, then we focus on optimizing the rest of your portfolio. This portion of a Safety-First Retirement Plan will involve some element of risk. However, there are different degrees of risk, and we only use strategies where risk can be monitored and controlled. Since this extra investing and spending (such as for extra vacations, nice restaurants, etc.) is discretionary, it won’t be the end of the world if you must reduce spending in this area at some point. You still have your guaranteed income floor in place to meet your basic needs, no matter what happens. With this sort of approach, withdrawal rates hardly matter.*
How people allocate their financial resources over a lifetime will determine to what extent they maximize their lifetime satisfaction. The purpose of saving and investing is to fund spending during retirement. Failure should not be an option when meeting basic needs!
Dennis Kagel is the president of Dennis Kagel Financial Services located at 321 Susan Drive, Suite A in Normal. You may call 309-454-9171 to schedule a no-cost and no-obligation visit to learn specifics about how the strategies they use can help you and your retirement.
*Wade Pfau Professor at The American College, opinions expressed as Forbes online contributor
**Michael Zwecher Economist quoted by Pfau in Forbes article