Making the decision to move into retirement is the biggest business decision that you make for your family. There is a lot to consider, and even more at stake. Over years of helping federal employees with their retirements, we’ve seen what works well and have identified some of the biggest influencers of success.
Retirement planning is a process, not an event. Sure, there are several events that involve looking at financial modeling, projections, strategy development, etc. and they often involve reports known as a “retirement plan”.
But the ongoing success of a retirement plan is not made real by simply having a plan. It is made real by the process of implementing and adjusting your plan over time.
Like your health, the ongoing maintenance of eating well, being physically fit, and regular check-ups help reduce challenges awaiting you. What gets measured gets strengthened and improved, and your financial independence is no different.
This article discusses factors that influence your financial success.
Risk Management
No risk, no return. This is a core tenet in investing, but risk does not always equal return. In fact, when you’re retired, preserving what you’ve built and making sure it lasts the rest of your lifetime is significantly more important than investing for a lot of growth.
Our clients want to know that they can count on their wealth to supplement their Federal Employees Retirement System (FERS) pension and Social Security and that regardless of what happens in the economy, they can continue to live their lives uninterrupted by the vacillations of the markets.
Another big risk many retirement plans fail to address is healthcare. Folks, your health is a big expense, and it gets bigger the further into retirement you go.
We’ve had clients in long-term care (LTC) facilities that cost close to $100K annually for the care they needed—the DC metropolitan area is expensive. But regardless of where you live, LTC expenses can be a torpedo to a retirement plan, and it’s a risk that you must factor.
But that’s not the only place where there’s risk. Where else is there risk for retirees?
The risk of not growing your money fast enough to replace what you spend and outpace inflation is a major one. Simply put, it is the risk of running out of money before running out of time.
This is one reason I take issue with labeling the TSP’s G fund as a “safe” investment option. It is safe from volatility, but not at all safe in helping you to sustain your lifestyle throughout retirement.
The cost of your daily lifestyle goes up over time. Your ability to keep up with such costs and maintain a pile of money from which to make withdrawals needs to outpace both your distributions and inflation. If your wealth stays stagnant or doesn’t grow fast enough, you will eventually run into trouble.
There is a brilliant graphic from Blackrock that helps illustrate this point. Not being invested properly will influence the sequence of your portfolio’s returns. The sequence of your returns is critical in retirement.
When a portfolio is in decumulation mode (retirement), this single variable can quite literally destroy a plan by itself.
The model below shows three portfolios, all three with the same annualized return, but differing sequences along the way. See the results.
Efficiency
Efficiency is something that belongs in every retirement plan in a variety of different ways. Mainly: low tax, low load.
First, there is efficiency in your overall plan. How organized is your plan? Do you have accounts everywhere? Have you pulled together all the information required for a proper retirement plan? Are you grabbing portions at a time? Is the information up to date? Have you systematized your plan? Are up-to-date laws factored current?
When families come to work with us, we give them a list of everything that’s needed for us to create a strong retirement plan. Financial planning is GIGO: garbage in, garbage out. If your inputs to the plan were done incorrectly, then the results of your models will also be incorrect.
But there’s also efficiency in your taxes. When you retire, that’s the first time in your life that you have full control over your taxes. Sure, your FERS pension and Social Security will be taxed, but the bulk of your retirement income gets to be designed however you want.
Having full control of how you design your retirement income plan means that you can have incredible tax efficiency and savings along the way. Every dollar saved in taxes is money that you get to spend on your retirement or reinvest instead.
Another place where you need efficiency is in your portfolio. I lost track of how many people I spoke to last year that had inefficiencies inside taxable accounts.
Here’s how you can tell: go look at your Form 1040 Tax Return. Do you have a Schedule D with your forms? Is there a number in line 13 of your Form 1040? If there is a positive number for 2022’s tax return, you’re missing out on massive value.
Last year was the true test. Many families saw huge portfolio drops due to the markets correcting. Not only did they lose value, but many families also had to pay taxes on top. Not good. The worst part is that it was completely avoidable.
There is also a matter of being efficient in your portfolio and considering risk-adjusted returns. Studies from Vanguard have determined that even more aggressive portfolios with better growth can have less volatility if they are properly implemented.
These risk-adjusted returns create portfolios that better support the income federal retirees are looking for.
It is possible that a 60/40 (stocks/bonds) portfolio that isn’t well maintained could be more volatile than an 80/20. Imagine having less growth potential but higher volatility. This occurs when drift isn’t addressed throughout each year.
Willingness To Take Risk
Discussing risk management and suggesting that one should take risk in the same breath seems counterintuitive.
It goes without saying that all investing has risk involved, including the loss of principal, but there should always be parts of your portfolio that are invested for some level of growth. Most retirements last for similar lengths of an entire career.
The Bucket Strategy
If you’ve read our other articles on the structure of portfolios, you’ll recognize the concept of taking a bucketed approach to your wealth. Without going into detail again, the concept is simple.
If you set up your wealth to be doing several jobs at once, you can allow the growth “buckets” to do just that—grow. With growth comes volatility. If you need your money during volatile markets, you risk selling investments at a loss to raise cash.
That’s where the more conservative “buckets” come into play. By design, they would be more conservative, and use investments specifically designed to generate cash flow and provide liquidity.
Doing so allows your cash flow to remain interrupted by the volatility that comes with growing your wealth. Then, you refill and adjust over time. Simple, but not easy.
Why not just have all your portfolio generating income? You are in retirement.
Let’s assume an annualized 3% inflation, and factor that inflation for a decade. If your money does not outpace inflation and is flat, you can expect your money to have roughly 30% less purchasing power over that time frame.
That’s a third less lifestyle that your money can support. As such, federal employees should have parts of their money that can be inflation-fighting and growing for them, so that future-you can have the same kind of spending power that today-you does. While Social Security and your FERS annuity do receive COLAs (cost of living adjustments), they do not keep up with real cost inflation.
Education and Understanding
The decisions you make are influenced by your knowledge. If we say to a client, “We think you should be invested more like this”, we want to make sure to take an educational approach in helping them understand the reasons why.
There are a few reasons for this. Having a solid understanding can give you peace of mind knowing that you have a game plan in place. This, in turn, makes it so that there is less risk of your wanting to abandon the strategy if and when the markets misbehave.
A good investment plan doesn’t mean there won’t be volatility; it means that the level of volatility is factored in towards still achieving your goals.
A successful retirement is not just about getting the maximum growth. Successful plans require the ability to withstand an appropriate amount of volatility.
But besides the economics is a sense of fulfillment and overall satisfaction that needs to be a part of it. Having a continual sense of financial independence is a big part of feeling good about your retirement plan.
You can have the most financially successful retirement plan, but if you’re constantly in fear of running out of money, or you just aren’t settled into a place of comfort, then I’d argue your retirement plan needs adjusting.
True retirement planning meets in the middle of both science and art, and that’s why all plans should be created differently.
If it were always a matter of only maximizing the money, here’s your plan: take Social Security at age 70, invest 100% in stocks, and never retire. Clearly, there’s more finesse required, so make sure to account for variables beyond just the numbers. After all it’s not just your money, it’s your future.
