Our wealth throughout retirement will look like a random walk because most of the key factors of retirement are probabilistic (see A Model of Retirement Planning, Part 1). Wealth will meander from its initial value at the beginning of retirement between increased wealth and insolvency.
Our wealth at all states (ages) of retirement will look like a time-discrete Markov chain because our wealth at our next age depends only on our current wealth and what happens in the coming year. In other words, if we have $1 million today, it doesn't matter if we got here beginning with $2 million or beginning with half a million. Our past finances are largely irrelevant.
Retirement finance also appears to act like or to be a chaotic system and whether it can be mathematically proven to be chaotic probably doesn't matter. (If it looks that much like a duck, it's wise to cover your head when it flies directly over you, see Retirement Income and Chaos Theory.) Our finances can enter positive feedback loops that will end in bankruptcy for about one in two hundred retirees, insolvency being a far worse outcome than the depletion of our savings portfolio alone (see Why Retirees Go Broke).
In simpler terms than those of statistics and probabilities, game theory and chaos theory, retirement finance is highly uncertain (risky), requires periodic adjustments and the bottom can fall out frighteningly fast.
This brings us to my last post, What Would a Good Retirement Plan Look Like?, in which I suggested that a good retirement plan is one that has a high probability of successfully meeting a retiring household's achievable objectives. If we accept this as the definition of a good retirement plan, then the next obvious question becomes how we define and integrate the goals of the household into the retirement planning process.
Goals and objectives can be strategic or tactical. Strategic goals are what we want to achieve. Tactics are how we will achieve our goals.
Successfully funding our standard of living for the remainder of our lifetimes is a strategic objective. Maximizing the household's inheritance might also be a strategic objective. Selecting an optimal withdrawal rate or asset allocation are tactical objectives.
One way to distinguish between the two is to consider whether you would measure retirement success by achieving that objective. If you were to constantly maintain the optimal sustainable withdrawal rate throughout your retirement but fail to maintain your standard of living, you would probably not consider retirement a success – it would fail the "Saint Peter test”, a thought experiment I described in What Would a Good Retirement Plan Look Like? Maintaining an optimal sustainable withdrawal rate throughout your retirement, then, is not a strategic objective but maintaining your standard of living is.
I expect that most people wouldn't consider owning a life annuity as an objective in itself, though it can be an excellent tactic for achieving the strategic objective of not running out of income before you die. Likewise, implementing a floor-and-upside strategy is not a strategic objective, but a tactic to achieve a broader goal. The point of all this is that a retirement plan should aim to meet our strategic objectives and that tactics are just a way to get there. Tactical objectives should follow from strategic objectives.
The best model I have found for a strategic retirement planning process is the one used by businesses. Although there are significant differences between developing a strategic plan for a business and developing one for a household's retirement, the overall process for the former seems a good model for the latter.
(Spoiler alert: the strategic planning process for businesses, as explained in the venerable MBA textbook, Strategic Management, Pearce and Robinson, will play a key role in future posts in this series.)
[Tweet this]A good retirement plan should begin with a mission statement explaining what you hope to achieve.
The strategic planning process for businesses begins with a mission statement. That seems like an ideal place to begin a strategic retirement planning process, as well.
While businesses use the mission statement, according to Pearce and Robinson, "to describe the firm's product, market and technological areas of emphasis . . . in a way that reflects the values and priorities of the firm's strategic decision makers", retiring households can employ a mission statement to identify their strategic objectives, or those things that, at retirement's end, they would need to have achieved in order to consider their retirement to have been successful.
While we are primarily discussing retirement finance, a mission statement should also include important strategic objectives that may impact our finances, like wanting to travel or earn a Ph.D. In fact, once we achieve the required state of intense pondering required to create a mission statement, it wouldn't hurt to throw in some non-financial but important goals like figuring out the true meaning of life or becoming a blogger.
Here's an example of a retirement mission statement.
- We hope to maintain our current standard of living throughout both our lives, though we recognize our spending desires will likely decline some with age.
- We don't want to be a burden to our children.
- We plan to pay for our children's education as far as they are willing to pursue it, but we have no fixed plan for an inheritance.
- We are not willing to risk our current standard of living to improve it or to increase our terminal wealth. Our standard of living is our priority.
- We want to travel abroad every year until our mid-70's.
- We prefer to downsize our home by age 75 to reduce maintenance.
Your statement can be longer or shorter, but it should at least encompass your feelings about risk, standard of living, plans for your home, and bequests. Notice it doesn't mention sustainable withdrawal rates, asset allocations, annuities or floor-and-upside strategies because those are tactics and not strategic objectives.
If you are setting out to develop a retirement plan, I recommend you create such a mission statement as the starting point. Satisfying this mission statement is the goal of your retirement plan. If you are about to pay someone else to develop a plan for you, the mission statement is a great way to communicate what you expect from the plan. A mission statement can help you and your spouse make sure you're on the same page. And if you already have a plan, I recommend you develop a mission statement, anyway, and compare it to the plan you have. Make sure your existing plan is set up to achieve your strategic goals.
Your first draft of the mission statement may not be your last. You may remember from a previous post that we amended the definition of a good retirement plan to define goals as reasonable (attainable). During the planning process, we may discover that some of the goals of our mission statement aren't achievable given our resources, in which case the mission statement must be revised.
On the plus side, we may discover that there are resources available to enhance the goals in the mission statement. But, figuring that out comes next at The Intersection of What's Desired and What's Possible, Part 6.