When we refer to your retirement number, most people think about how much money they need to save to meet their retirement goals. Knowing a specific retirement number is nice; it can provide you with a seemingly concrete, attainable goal. But is it truly valuable in the context of planning for retirement?
We’d love to say “yes,” but it may be an over-simplification. Believing that there is a perfect retirement number is just too simplified to be realistic, at least for most people. The retirement-number concept caught on precisely because it is so simple and carefree. Everyone wants to plug in a number, reach that number, and then move into retirement without a second thought.
Sorry folks, it’s usually not going to be that straightforward. It is crucially important for investors to understand the true, more complicated, nature of retirement.
Life is full of unexpected events, and that won’t change when you enter retirement. In fact, if you plan to retire at 65, you could spend 20 years or more in retirement. Just think how things can change over two to three decades. In 1998 (two decades ago from this post) the film Saving Private Ryan was released and seeing it in theaters would have cost a little more than $4.50. Compare that to the average price of a movie ticket today – nearly double the price at around $9.00 a movie! In 1988 – 30 years ago – the film Rain Main was released, and the average U.S. ticket price was $4.11 (as a digression, I’d be curious to know how much of this increase was related to 3D movies).
But let’s get back to the concept of a “retirement number”: If you retired with $1 million, you’d have a very different retirement experience depending on whether the stock market crashed the day after you retired or soared for the first decade of your retirement. Likewise, health problems or family issues could change your financial-security outlook. Even overspending during the early years of your retirement could throw a wrench into your plan.
These are great examples of why the highly simplified “retirement number” can be misleading, and possibly even dangerous, to your future financial security. A much more realistic approach is required.
Introducing Monte Carlo
No, we’re not talking about vacationing at a glamorous location. Monte Carlo simulations are mathematics-based analyses that attempt to make sense out of ambiguity and random variables-in other words, your retirement.
The concept of a retirement number makes planning appear to be black and white, but retirement planning is anything but. Monte Carlo simulations can help to add the necessary shades of grey that give you actionable knowledge.
These simulations use details based on your existing situation to analyze thousands of hypothetical retirement scenarios to determine your likelihood of success. For example, let’s say you want to retire at 65, you want to maintain your current lifestyle throughout your lifetime, and you want to do so using the assets you’ve already accumulated. A Monte Carlo simulation will run thousands of hypothetical market scenarios (thereby playing out situations in which the market tanks shortly after your retirement, or roars), and combines those market possibilities with your desired and planned cash flows. Personal Capital’s Monte Carlo software uses 5,000 scenarios. In the end, you will receive a probability-of-success ranking of low, medium or high.
The next step is up to you. There are many individual “levers” you and your advisor can pull to make your situation one that has a higher likelihood of success. For example, you may discover that you have a medium probability of successfully meeting your retirement goals. To potentially improve your probability of success, you could delay your retirement, save more now going forward, adjust your investment strategy and risk profile in the hopes of higher returns, or reduce your planned retirement spending. You could “pull” any or all of the levers to work towards increasing the probability that your investments sustain you throughout your retirement. Or, you can stick with your plan and acknowledge that some flexibly on your part may be required. This could mean actions such as downsizing your lifestyle later in your retirement, working a part-time job, or moving in with family. The choices you make entirely depend on your personal comfort level with flexibility.
Monte Carlo is an Ongoing Process
As you may have guessed, Monte Carlo-style planning is never done. Unlike a static retirement number, your actual life scenario is constantly changing, and your probability for retirement-goal success changes constantly, too. For example, inflation is a huge potential variable for retirees. Monte Carlo simulations can help you monitor the consequences, if inflation becomes a significant factor.
No one can predict the future, not even the best Monte Carlo simulations. However, a mathematics-based approach to retirement planning can give you a realistic picture, which is an excellent starting point. The goal is to understand your situation and continually work toward improving it. If you use Monte Carlo simulations, you won’t be hitting the retirement switch and checking out, but you will have a higher sense of control because you’ll be continually evaluating the impact of new information-and adjusting as needed.
You’re not a number, and your retirement-planning approach shouldn’t be, either. If you want to develop a retirement plan based on your personal reality and adjusted as your life circumstances change, you may need some guidance.
Personal Capital Advisors Corporation is an investment advisor registered with the Securities and Exchange Commission (“SEC”). Any reference to the advisory services refers to Personal Capital Advisors Corporation. Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk.
Paul Deer, CFP®
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