Friday, February 15, 2019

Retirement Advice from a Prussian Military Commander

We have to understand both the nature of plans and the nature of retirement finance before we can build a successful retirement plan.

[A version of this post first appeared at]

It's only rational to update any plan (not just retirement plans) to account for new, important information. Say that on Monday, the weather forecast for Friday is warm and sunny so we plan a day at the beach. If the weather forecast on Thursday changes to a wet and cold Friday, then we need to change our plans. It no longer matters on Thursday what conditions were last Monday.

While that no doubt sounds obvious to all of us, not everyone thinks about retirement plans that way. As a top retirement researcher recently pointed out, “Your retirement plan is probably wrong in less than a year.” Or, to paraphrase a Prussian military commander from 1880, no plan survives initial contact with the enemy.

In retirement planning, uncertainty is the enemy.

Key retirement plan inputs can change every year. Our remaining life expectancies will decline a little less than one year for every year we survive and we're one bad checkup away from downgrading that.  It can change significantly for the better, too, as CML leukemia patients experienced with the introduction of the miracle drug, Gleevec.

Your retirement plan may only be a good one until its next encounter with the enemy.
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We may marry, get divorced or become widowed. Our investment portfolio will likely go up or down, perhaps by a lot at times.

We may experience expense shocks or receive an unexpected inheritance or not receive an expected one. Our expectations of market returns and our risk tolerance can also change.

As I mentioned in a series of posts at The Retirement Cafe, the first step of retirement planning is to define our financial goals. Goals can change dramatically, too. A plan to pay for a grandchild’s college education might change, for instance, when she gets a full ride to her chosen college.

These are all critical inputs to a retirement plan and if they change, your plan should change along with them. Receive a large, unexpected windfall and you may want a new plan. Notice that your savings portfolio is half-depleted after the first five years of retirement and you need a new plan.

Again, this may all seem obvious but when it comes to retirement plans, some of us think, “What the heck, this plan was good enough in 2001 so it’s good enough for today!” Or, “I only need a planner when I retire and I’ll just tweak that plan for the next 30 years.” Or my favorite, “I can safely spend $35,000 this year because that was 4% of my portfolio value when I retired 20 years ago.”

We can think we understand the need to change our plan but plan in ways that belie that understanding.

Some retirees and planners who would agree this is obvious also believe they can determine a safe amount to spend throughout retirement based on their financial situation back when they first retired (the so-called 4% Rule). Liabilities don’t care how much money you used to have—that's last Monday's weather forecast.

They might also believe they can develop a retirement plan today that will at worst need “tweaking” from time to time. That would be a lucky coincidence, indeed. Or, that their estimate of the size of their estate 30 years from now is somehow accurate. Or, that they can know at age 65 what their asset allocation should be when they are 85. So, we can say that changing our plan to accommodate changes in our situation is obviously necessary but plan as if it isn't.

Some important observations can be made when we accept that a rational retiree will change her plans when her goals, resources or expectations change significantly.

The first and most important observation is that retirement planning is a lifelong endeavor.

Plan updates often require more than having a planner calculate a new safe spending amount annually or rebalance your portfolio. The entire plan needs to be reviewed annually or anytime there is a significant change in your goals, resources or expectations.

The good news is that you can change many facets of your retirement plan fairly easily at any time, though some retirement decisions are essentially irreversible. It is difficult in the U.S. to un-buy annuities, for example, but easy to buy more. You can mitigate this by annuitizing in smaller chunks over time. For all practical purposes, you can’t un-claim Social Security benefits (there are limited exceptions).

You probably can’t re-enter the workforce after more than a few retired years with anywhere near your previous pay. You need to make these decisions with great care and understand their irreversible nature.

Choose to spend from an investment portfolio and you probably won’t be able to rebuild it should it become significantly depleted. You might need to take remedial action quickly to avoid a dangerous level of depletion and you often won't be able to take it fast enough. You'll need a new plan.

Most of the other important retirement decisions, however, can be re-made every year. You can even change your strategy. Perhaps as you get older you will become more risk-averse and trade your floor-and-upside strategy for an annuity strategy or more risk-tolerant and invest more in equities.

Being able to substantially revise your plan every year also means it’s never too late to develop a plan if you don’t have one.

Our financial circumstances, goals, and expectations can change dramatically from year to year. It’s irrational to imagine that our plans won't need to change accordingly or that our plan's probability of succeeding hasn’t changed.

Retirement planning is a lifelong process and your current plan may only be a good one until its next encounter with the enemy.

Economist, Zvi Bodie provides a wealth of life-cycle economic, or "safety-first" retirement finance information at Readers who appreciate advice dispensed in video format will find that section quite rewarding. I am especially fond of one of the longer videos (about an hour) entitled "Zvi Bodie on Investing for Retirement."

Monday, February 4, 2019

Honey, What's Our Retirement Plan?

Retirement planning is a complex problem we can simplify by first focusing on what matters most. The key is getting the big decisions right.

[An earlier version of this post appeared at on January 25, 2019.

The "big picture" retirement finance problem definition is straightforward. How can we work for perhaps 40 years to pay our household's living expenses and simultaneously save enough that, when combined with Social Security benefits and pensions, we can maintain our desired standard of living for one to perhaps 35 more years?

Straightforward, but daunting, right?

The most important step, often given too little consideration, is defining the goals and challenges for your unique household (see The Retirement Plan I Would Want - Part 7). Identifying and agreeing your retirement financial goals with your spouse and planner is a critical first step before the financial strategy even comes into play.

Sometimes, one spouse wants a total return investment plan and the other just wants a guaranteed monthly check for life. On occasion, I even find a client who has self-conflicting goals of his or her own, like wanting to maximize retirement spending and leave a large bequest (a perfect example of wanting to have your cake and eat it, too, by the way). It's difficult to solve a problem when no one agrees what the problem is.

Once the goals are resolved, we can attempt to meet them financially. There are many factors we might consider but some are far more important than others.

The most important factor in determining retirement outcomes is how long we will be retired. Nearly anyone can maintain their standard of living throughout a retirement that lasts a year or two but far fewer households could fund one that lasts 40 years.

We can't predict how long a healthy retiree or retired couple will live, what we call "longevity risk," so the safest bet is to plan for a long, expensive retirement. But, you may not want the safest strategy. Perhaps you're willing to take a little more risk hoping to spend more. This should be clearly evident from your agreed goals. If it isn't, your goals need more work. Regardless, there is one inescapable fact: if you spend more you will have more risk.

The key to retirement planning is getting the big decisions right.
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If you're with me so far, then the most important decision of retirement planning—the first "big decision"— is how to deal with longevity risk and that is largely determined by the funding strategy we choose.

Many funding strategies have been proposed in the research literature so even this first step can seem intimidating. Wade Pfau and Jeremy Cooper identified eight proposed strategies ranging from safety-first (expensive but safe) to probability-based (less expensive but riskier)[1]. If you haven't heard of most of them, there are good reasons. Some are too complicated for retirees and advisors to grasp, some are challenging to implement, and some are not broadly palatable, like using a triple-leveraged risky portfolio for the Floor-leverage rule.

How should we choose from this extensive menu? Actually, I suggest that you don't.

I'm going to make a claim that may sound a bit outrageous: there is only one grand retirement-funding strategy. That strategy is to allocate some amount of retirement plan resources to generate a floor of safe lifetime income, to invest the remaining assets, if any, in a risky aspirational portfolio, and then to decide how to spend the risky assets throughout retirement. The correct balance will depend on how willing you are to risk losing your standard of living for the chance of having an even higher one.

We can allocate zero dollars to the floor portfolio, in theory at least, and have a purely total return strategy. In reality, nearly all Americans are eligible for Social Security Benefits or a public pension and will, consequently, have some floor whether they want it or not.

This grand strategy may simply sound like the strategy we call "floor-and-upside" (see Unraveling Retirement Strategies: Floor-and-Upside). But, choose to allocate nothing to the safe income floor portfolio and to spend 4% of the initial value of the risky portfolio and we have a "sustainable withdrawal rate" strategy. Change the "4% of initial portfolio value" spending rule to "4% of remaining portfolio value" or RMD-spending, for example, and we have one of Pfau and Cooper's variable-spending strategies. They're different takes on the single grand strategy.

Retirees who fund part of their spending needs from a risky portfolio will also need a spending strategy. For them, this will be important decision number 1(b).

By making the important decisions first instead of selecting from a list of strategies, you can simplify the planning process. Decide how much risk you are willing to take with your standard of living in exchange for the possibility of improving it and allocate retirement resources to your floor and risky portfolios accordingly. If you decide to fund a risky portfolio, then also decide on a spending strategy that equally fits your risk tolerance.

These decisions will have a far greater impact on your outcome than say, tweaking your equity allocation 5% or worrying about whether equities get safer the longer you hold them. You may find that this process provides a better high-level understanding of your retirement plan. You may even be able to describe the important parts of your plan in a couple of sentences.

"Honey, what's our retirement plan?"

"Glad you asked! Here's the big picture in two sentences. . ."

How sweet would that be?

Identify your goals, get the big decisions right, and your plan will be 80% to 90% of the way home.


[1] The Yin and Yang of Retirement Income Philosophies, Wade Pfau and Jeremy Cooper.

[2] The Retirement Plan I Would Want - Part 7, The Retirement Cafe.

Friday, January 25, 2019

When the Market Kicks Like a Mule

Retirees are just now opening their 401(k) statements after an ugly fourth quarter and raising the inevitable question spawned by every significant market decline: should I rush for the exits?

There will be the requisite response from every financial columnist in the country and most will say, "do nothing."

Ah, if life were that easy!

Here's my alternative response. First, what you should do depends on your age and whether you are in your earning years, approaching retirement, early in retirement, or late in retirement. For those still working with at least a decade until planned retirement, "do nothing" is often a good idea. You have many years for the market to recover and to save more.

It might be a good answer for those in the other three life stages, too, but that depends entirely on your financial situation. I wouldn't hazard a suggestion without those details.

Regardless, a significant market downturn can be very educational. During a long bull market, it's easy to decide that you're a risk-taker and that a 25% decline in the S&P500 index wouldn't prompt you to panic-sell at a market bottom. But, you truly understand your risk tolerance only when the decline is actually happening.

My goal for clients is to make them so comfortable with their investments that, like me, they never even think about market downturns. If last quarter's market correction caused you significant anxiety, what it hopefully taught you is that you have too much invested in the stock market. In that case, the correct answer is to sell some of your stocks (as your stomach is trying to tell you to do) and invest the proceeds in something safer, like CDs or a short-term bond fund.

I have about 40% of my portfolio invested in equities so it is unlikely that I will lose more than 15% of my total portfolio in a severe downturn like 2007-2009. A temporary dip of that magnitude wouldn't threaten my standard of living so I ignore downturns.

A friend called this week, noted that her 401(k) had declined in value last quarter and asked what I thought she should do. Some of her colleagues were bailing out of the market but her inclination was to do nothing. She got it right. Perhaps they did, too.

The first question I asked was if she thought she would need to spend the money in her 401(k) investment portfolio anytime soon. Her answer was no, so I told her to ignore the market until she has a need to spend from her portfolio.

If you don't need the money anytime soon, then you needn't care if stocks decline in value temporarily. Those lower prices are what someone would be willing to pay for your stocks today but you're not going to sell them today.

If you have money that you will need to spend in the next 5-7 years, then it shouldn't be invested in stocks. You might be forced to sell stocks at market-bottom prices to pay those expenses before the market has a chance to recover. There is no guarantee that stocks will recover from losses in 5 to 7 years, either, but the odds are pretty good that they will.

Selling stocks and getting back into the market later is called market timing and it is a terrible idea. Research shows that hardly anyone can successfully time the market and investors who try consistently lose money. If you decide to sell because you have too much invested in the market and it's keeping you awake at night, don't be tempted to buy back in during the next bull market. That's a loser's game.

A good retirement plan, by the way, would anticipate market declines and tell you how to deal with them.

Get off the Rolaids Treadmill in two steps. Take any funds you expect to spend in the next 5-7 years out of stocks and put them in a safer place. Then make sure the amount that remains in stocks doesn't exceed your risk tolerance.

As a guideline, investing 40% of your portfolio in stocks would probably result in a 15% portfolio loss in the worst of bear markets compared to a 25% portfolio loss for a 60% stock allocation.

If you lost enough of your portfolio in the recent downturn to cause you pain, don't waste a learning experience. Fix it now. As a Senator from Kentucky likes to say, there's no education in the second kick of a mule.

And that's a record for me—a two-blog post day. You can check out the other at Now, I need to soak my overworked fingertips (metaphorically) in a glass of something else Kentuckians like to say.

Friday, January 18, 2019

Take Your Best Shot at a Retirement Plan

This column was first posted at on January 11th. I will continue to post here at The Retirement Cafe´and the columns that originate here will tend to more in-depth. I invite you to follow me at both blogs ( and and on Twitter as @Retirement_Cafe. You can receive my posts via email by entering your address in the "Follow by Email" box in the right column.
I've been retired for more than a decade and I'm often asked about my biggest retirement regret. It's an easy call for me. I most regret retiring with an inadequate understanding of the risk I was taking.

It could have been disastrous. Research documents the risk of poor investment returns early in retirement, "sequence of returns risk," and I retired in 2005, just before the Great Recession. A relatively conservative equity exposure and substantial retirement savings saved me and I weathered the storm quite well. Still, I have the lingering feeling that I won a bet without fully understanding the odds.

Sometimes it's better to be lucky than good.

A better description of my mistake is that I was more focused on investment performance than the risk to my standard of living. I've come to understand that retirement planning is, from most perspectives, more risk management than portfolio management, although the latter seems to get all the love.

Retirement planning is often explained in terms of two schools of thought, a probabilist school and a safety-first school. Probabilists focus largely on maximizing portfolio returns and minimizing the probability of a shortfall. In a sense, they try to outrun standard-of-living risk with better portfolio returns.

In the safety-first school, the goal is to first insure the risk of an unacceptable standard of living with annuities, maximized Social Security benefits, TIPS, bond ladders and the like, and only then to pursue greater portfolio returns. For safety-first advocates, almost any probability of a disastrous outcome is too much risk.

We can look at retirement income as a portfolio optimization problem in which we try to sustain or improve our desired standard of living. The downside is that we could make it worse.

Alternatively, we can view it as a risk management problem and try to minimize our risk of losing our standard of living as we age, at the possible cost of limiting our upside. Of course, nothing says we can't choose a goal in between that better fits our risk tolerance, insuring more or less downside and risking more or less upside.

A result of focusing my retirement decision primarily on investing is that it drew my attention from the other risks of retirement, like unexpected expenses. There was a risk that I would have high medical expenses and very expensive health insurance (I did). There was a risk that my adult children would need substantial financial assistance (they did). There was a risk that we would retire into a brutal bear market (we did.) There was a risk that I wouldn't be able to buy affordable long-term care insurance (I can't).

There were dozens of other risks, some manageable, some not, that I didn't consider but would have had I approached my retirement planning more from the perspective of risk management than simply as an investment game.

As I said, I weathered the first decade of my retirement in great shape. Still, I feel a little like a basketball player who took a really poor game-deciding shot and somehow saw it go in.

If I had it to do over, I'd take a better shot.


Retirement is a Risky Business –– Here's a List, Dirk Cotton.