The #1 fear that the clients that I work with have is running out of money in retirement.
It comes as a surprise to many that one can fairly easily determine how long an investment portfolio will last in retirement, even with the level of uncertainty that is created in the markets.
There are three primary factors that influence how long investments last in retirement.\
The first factor, which should be calculated in advance, is how much per year needs to be withdrawn from an investment portfolio to meet all needs and goals.
The second factor which determines the longevity of an investment portfolio relates to the risk and return characteristics of the investments that are owned. Although no one can predict the future, investments tend to fall within a predictable range of returns over a long period of years. The range of returns that could be expected if similar type of market cycles occur in the future is measured by a portfolio’s “standard deviation”. The standard deviation simply describes how much a portfolio can fluctuate from its average return over time. You can easily calculate an investment portfolio’s standard deviation by using research programs such as Morningstar.
The third factor that determines the longevity of investment portfolio relates to how the first two factors interact with one another over time. In other words each year there is a certain amount of investment withdrawals that may or may not take place to meet income needs. These investment withdrawals are happening simultaneously with the up-and-down fluctuations of an investment portfolio based upon the level of risk or standard deviation that the portfolio experiences.
Software tools which incorporate Monte Carlo analysis can easily predict the likelihood of success of an investment portfolio based upon the three factors mentioned. Although the future may not behave like the past, it is the only basis we have for research and testing.
Monte Carlo analysis runs hundreds and thousands of possible retirement scenarios within the range of returns and investment portfolio is likely to have along with the simultaneous planned withdrawal rates in order to come to a percentage likelihood success.
Thoroughly testing your current investment portfolio against planned withdrawals is a great first step to determining whether or not there are ways to better improve or optimize the outcomes of your retirement.
The good news is that with the software and technology that we have at our disposal, we do not have to make changes to our investments in order to improve or optimize them. Instead we can test the results of tweaking investments before making changes or commitments.
It’s similar to the way that an architect and homebuilder may complete the home building process. Elaborate blueprints are completed and all change orders or modifications are completed in the blueprint format rather than after the home is complete.
Another apt example could be the process of adjusting your contacts or eyeglass prescription. Many slight adjustments are compared to one another in order to determine the proper prescription before it is sent to the technician.
You should also treat your retirement results in the same manner. You do not have to change your plan or make long-term commitments to strategies and wait for a number of years to determine whether your changes created the intended result. You can test the impact of all investment strategy changes in the blueprint stage to make sure that the results conform to what you’re looking for and what matters most to you.
If you would like more information about our “Retirement Results – In Advance” process, please contact me.
