You are 55 years old and retirement is no longer a thing of the distant future. In fact, you and your spouse seem to find yourselves discussing your retirement goals more and more frequently. You have considered your desire to travel the world, your desire to have the financial flexibility to be able to visit children and future grandchildren who are spread across the country. You consider the quality of healthcare you would like to be able to afford, the type of home you want, the type of cars… Yes, you are very aware that the way that you handle your finances over the next 15 years is going to largely determine the quality of retirement that you enjoy.
When the stock market rises, you feel increasingly optimistic about your financial future. However, when it falls you start to get nervous and have even had knots in your stomach at times. Perhaps, you have even considered leaving the stock market for good in order to just invest your money in certificates of deposit where at least you know that you will get your money back with some modest return.
Some variation of the thought process described above is commonplace among those who see retirement on the horizon. Any time the financial markets experience turmoil, it is natural for investors to ask themselves why they voluntarily signed up for this! During such periods of introspection, it is a must to ponder the reasons for investing in the first place. Despite the ever-present risk of loss that exists in the financial markets, the financial markets also present one of the best available means of accumulating wealth. It is also at times of market turmoil that the consequences of “dialing down the risk” must be considered.
The table below highlights the differences in annual distributions for 6 different investors who each arrive at age 55 with $1 million in savings. It makes many simplifications and does not consider inflation, additional savings, alternative methods of distribution, and other factors. However, its purpose is to highlight the impact that the rate of return earned on the $1 million over the 15 years from age 55 to 70 of the hypothetical investor have on the annual distributions from age 70 through 95. It assumes that the entire value of the portfolio is removed from the markets when the investor turns 70 years old and then simply divides the value of the portfolio by 25 in order to get the annual distribution amount.
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Molly Mattress decides that she doesn’t need the stress of investing. She is simply going to hide her money under her mattress and enjoy her life without having to worry if her money will be there in the future or not. While it is true that the risk of short-term loss is no longer an issue for Molly, she also is left with only $40,000 per year from age 70 until age 95. Cindy CD at least earns interest on her money (2.78% is the current average interest rate on 5-year certificates of deposits, according to www.bankrate.com.) By taking this action, Cindy is able to bump up her annual distribution to $60,352 per year. On the other end of the spectrum is Venturesome Vic who earns an annualized return of 10% on his money for 15 years and is then able to enjoy distributions of $167,090. Cautious Kate, Average Alex, and Optimistic Oscar fall in between those extremes.
Does this focus on the amount of the annual distributions change anything? It should. After all, it is easy to focus on the here and now and focus on avoiding short-term losses. However, permanent reductions in risk tolerance when an investor is still potentially decades away from “pushing up daisies” may result in a very modest and potentially unpleasant standard of living during the retirement years.
Very good article that I use!
I am glad you found it useful.
This is very interesting I will share it with my clients