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Retirement Planning Is Dead

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Key Ideas

  1. Why traditional retirement planning as we know it is a completely broken system failing far too many people.
  2. 8 important facts to take into consideration when thinking about how to plan for retirement.
  3. An explanation of the volatility effect, which is crucial to understand if you hope to afford retirement.

Traditional retirement planning has failed.

  • According to the New York Times, 75% of Americans have less than $30,000 in their retirement accounts, and 49% of middle-class workers will retire poor or near poor.
  • According to Hewitt Associates, 4 out of 5 workers will fail to meet all their financial needs in retirement.
  • Employee Benefit Research Institute reports that 81% of workers nearing retirement age (45 or older) have less than $250,000 in savings, and an astounding 48% have accumulated less than $25,000 as they approach retirement.
  • Only 14% of American workers are confident they will have enough money to retire, according the annual Retirement Confidence Survey.

The evidence is overwhelming that something is wrong with traditional retirement planning. It’s an old world model in need of a major facelift.

The problem is baked into how the retirement system is designed—it’s not realistic. The skills and knowledge required to successfully execute a traditional retirement plan are beyond most worker’s abilities:

  • You must voluntarily save a significant portion of your income with discipline throughout your career (8%–30%, depending on the age you begin saving).
  • You must develop sufficient investment expertise to implement smart asset allocation and investment decisions.
  • You must know in advance when you and your spouse will die to know how much savings are required.
  • You must know in advance when you will end work—either voluntarily, due to sickness, or possibly because of lay-offs out of your control.
  • You must know what the future inflation rate will be over your remaining life (even though trained economists can’t accurately predict this number even one year in advance).
  • You must know what your investment portfolio will return over your remaining life (even though nobody can predict this number for one year, not to mention 30 years).
  • You must be disciplined enough to never raid your retirement nest egg when adversity strikes, like getting laid off, health problems, kid’s college, or getting divorced.
  • And then, to top it all off, you’re supposed to manage your retirement savings so that you spend your last dollar as you exhale your last breath.

Yeah, right! No wonder most workers are failing at retirement planning.

It’s an almost unbelievable list of skills and knowledge that few, if any, workers possess. It requires you to have the savings discipline of a celibate monk living in a brothel, investment skills that exceed most pension and mutual fund professionals, and the actuarial skills of an insurance expert.

Those sound like pretty demanding standards for someone who aspires to quit work.

Traditional retirement planning is a broken model. The system is failing people because the absurd list of skills required to succeed is unrealistic.

Why Traditional Retirement Planning is Failing

Walking the Talk Makes All The Difference

The reason the broken model persists is because most “retirement experts” that teach this stuff have no real experience being “retired”, living off their portfolio, and surviving without earned income.

Reality is very different from theory: the retirement map most experts teach is not the territory.

After “retiring” a decade and half ago and raising a family of four with almost no earned income, I can tell you that retirement living isn’t nearly as neat and clean as the sterile books would (mis)lead you to believe.

I’ve survived multiple bubbles in stocks and real estate (and probably bonds someday soon), and the conventional rules of thumb are hazardous to your wealth.

Below are some particularly important ideas you’re not likely to hear about from a traditional financial planner at your next retirement planning meeting:

  • Increasing Longevity Has Changed The Rules: Life expectancy is increasing every year, and the higher income classes can expect the greatest longevity in old age. If you have the wealth to fund a secure retirement, then you should also expect to outlive the averages (unless your genetics indicates otherwise). 90% confidence intervals for a healthy couple at age 65 are already growing past the age 100 barrier. In other words, forget the statistical averages. You must financially prepare to live far longer than anyone would tell you, because the alternative is to risk outliving your money, and that’s not acceptable.
  • Spending Principal Is Dangerous: When your assets have to survive 30 years or more, it means you cannot safely spend investment principal like conventional retirement planning would indicate. This means you must live on portfolio income exclusively during the early years, because there is no safe way to amortize principal over a 30+ year time horizon, given all the unknown variables (see The 4% Rule and Safe Withdrawal Rates for more detail). That requires you to amass a much larger investment portfolio than traditional retirement planning would indicate, or consider alternative portfolios to produce inflation adjusting income and growth.
  • Inflation is Your Number One Enemy: Inflation is the number one nemesis of retirees. That’s because a retiree is, by definition, a saver, and inflation is the cancer that consumes savings. Inflation is all the more insidious because you have no control over it, can hardly detect it from year to year, cannot estimate it accurately, and small differences will compound over many years to potentially double the amount of money you need to safely retire. Inflation is one of the top risk factors to your financial security.
  • It’s Tough to Grow Purchasing Power While Living Off Savings: It’s exceedingly difficult to grow a portfolio fast enough using conventional, passive, asset allocation to increase your saving’s purchasing power net of inflation, lifestyle expenses, volatility effects, and the inevitable mistakes and surprises of life. Few people grow their portfolios faster than inflation after subtracting just transaction costs, mistakes, and other issues. When you start subtracting lifestyle expenses from your savings the hurdle is extraordinarily difficult to clear.
  • The Average Return Lie: The big reason it’s so difficult to grow your assets net of inflation, spending, mistakes, and investment expenses is the “average return lie”. The experts love to quote average historical returns, but the only return you can actually spend is the compound return. Average returns are a statistical fiction. The seldom-told truth is that compound returns are always less than average returns, and the culprit is volatility. The greater the volatility the greater the difference between average return and compound return. For example, if your investments are up 50% one year, and down 50% next year, then the average return is break-even, but your account actually lost 25% when compounded. The 25% loss is the only return that matters to a real retiree, and it’s caused by the volatility effect.
  • Sequence of Returns Risk: Now that you understand the volatility effect, let’s add insult to injury by introducing sequence of returns risk. You will quickly see why living off your retirement nest egg is more risky than commonly understood. Imagine an adverse period of returns that runs a decade or more. This occurs regularly in actual market history with the most recent example beginning in 2000. If you started your retirement in 2000 with a conventional passive indexed portfolio, and supported living expenses from assets according to the conventional 4% rule, you would have incurred a portfolio drawdown just from spending that exceeds 50% (not to mention investment mistakes, investment expenses, volatility effects on compound return, and more). Given the dismal investment returns over the same time period, your monthly spending would be approaching or exceeding 10% of assets (depending on assumptions), which is unsustainable and certainly not safe. This isn’t some theoretical mumbo-jumbo – it happened to countless real-world retirees who relied on conventional wisdom and got burned. It results from an adverse sequence of investment returns like we’ve had since 2000. Research shows this sequence of returns risk during the first 10-15 years of retirement accounts for 80% (or more) of the variance in safe withdrawal rates during retirement. It is incredibly important to understand, yet few retirees do. Make sure you fully understand exactly how this works, because it will make or break your retirement security.
  • Poverty Consciousness: The process of living off your assets with no earned income creates a poverty mentality for anyone successful and actuarially minded enough to build the wealth in the first place. It causes a feeling of lack, even though you’re surrounded by a plentiful portfolio. It is why you see multi-millionaire elderly people in their 80’s pinching pennies and refusing to enjoy their money, even though they couldn’t spend it all if they tried. It’s difficult to understand until you live it. Basically, your financial reality narrows when you become 100% dependent on your assets with zero earned income. The result is tragic: a poverty experience, even though you’re surrounded by abundance.
  • Forget the Clichés About Retirement Happiness: Finally, a satisfying retirement isn’t anything like the clichés indicate. A fulfilling life is built on much more than endless rounds of golf and little umbrella drinks under a palm tree at sunset. I’ve tried all extremes from workaholic to pro-leisure circuit, and everything in-between. In my experience, the most satisfying retirement includes a lifestyle business that produces some income without inhibiting the freedom to do what you want with your life. It takes pressure off your assets and relieves the poverty mentality while providing a sense of purpose, community, mental stimulation, contribution, and social connection. Vacations are more enjoyable when contrasted with meaningful work. The truth is, work provides underrated benefits during retirement, because most people need something more to wake up for than just personal self-indulgence.

In Summary

If you want to learn more about how the financial aspects of retirement planning work, make sure to pick up my latest book: How Much Money Do I Need To Retire? Retirement planning doesn’t work in practice like most experts preach. The differences aren’t small either. They are game changing.

From saving, to investing, to life planning, the retirement experience operates under a set of rules very different from what is commonly believed.

In the comments below, please add to this discussion by sharing your experience with traditional retirement planning. How will your retirement differ from your parents and grandparents? What has worked for you in traditional retirement planning, and what hasn’t? What are some of your favorite ideas in retirement planning?

I’d really like to know what you think about these ideas…

19 comments
rjrboka
rjrboka

@mdrealestateBob

I am so glad to real i am not nuts. I have worked since I was 19 (now 60). I have tried to retire 3 times. My son calls me the Bret Farve of our family. Your comment " The process of living off your assets with no earned income creates a poverty mentality for anyone successful and actuarially minded enough to build the wealth in the first place." is so TRUE. I have be forced into retirment due being in the finance industry.  

I have been lucky (through hard work) to amas a muli million dollar nest egg. I have lived frugally. I put thre kids through doctorate and mastes programs. They are all very sucessful themselves. But I still feel like I may outlive my money. Although I considered the loss year and good year would average the 6% returnand that would work. But, due to you also pointing out the compounding return it make me more nervous.

I definitly see myself and wife as the see multi-millionaire elderly people in their 80’s pinching pennies and refusing to enjoy their money even though they couldn’t spend it all if they tried.

Becasue of you article at least i won't waste money on a therapist. I am not the only one with poverty mentality.

NoDeliveryPizza
NoDeliveryPizza

Great Post Todd! I bought your book "how much money you need to retire" and loved it.

Do you plan on writing more about Poverty Consciousness (blog or book)? I believe it to be one of the most underrated predicaments of having to spend your principal.

Thanks.

kamily
kamily

Glad to share. Due to my experiences, I have been involved in trying to improve the retirement infrastructure in my country and, I'm planning to write a book next year about wealth creation and value system. The idea is to recap my experiences/principles on money,values and life as a guideline for my kids.  

mrsmelon
mrsmelon

I guess we COULD all pay $1800 per month.....IF we don't eat, drive, live in a house, have a life. As far as I can tell, if anything is going to do us in, it's healthcare costs. It's a wildcard in terms of planning. We all need to win the lottery. :)

mrsmelon
mrsmelon

We got a wake up call recently when we found out that a big chunk of our retirement money will be going to our health insurance premiums when we retire. And this is the plan that our employer will "provide". I can't even imagine what it would cost on the outside market. I have much research to do prior to our retirement, if we can even retire! Those traditional "estimate what you need to retire" models are so obsolete! There is a new reality we all need to wake up to. 

kamily
kamily

Good and practical article! I'm 61 now,retired at 55, and due to curve balls I had encountered in life, am rebuilding my retirement funds! I'm living retirement and in hindsight wiser, more so then the financial advisers I've come across. My retirement planning was all in my mind, and patchy at best! Both my late wife and I thought we would have enough for retirement, but the curve balls started coming in. Due to unavoidable situation my wife resigned as a manager from her bank. We became a single income family with three growing kids! And it was difficult for her to get a job in her forties. Second curve ball, my eldest daughter, due to circumstances, ended up studying at a university overseas, which took a big chunk of my retirement savings! Third curve ball, my wife had cancer for three years and eventually passed away.  Fourth curve ball, I invested in an investment scheme much against my own common sense- too good to be true! And the final curve ball, if I can call it that, is I subsequently retired. No financial coach can prepare anyone for lives' curve balls, especially when one is grieving and looking after three kids and holding a job at the same time. The last three curve balls happened within a space of six years, and I'm glad to say that I'm moving on now. Sometimes in such situations, the focus is on keeping the family together, healing oneself, and coming to terms with retirement concurrently, not on savings or wealth creation. But I'm getting there!

rufflanding12
rufflanding12

Great article!  My husband and I struggle to max out his 401k, and i save 85% of my part time paycheck for retirement.  We are surrounded by co-workers that eat out everyday and watch their paychecks dissapear at the bars on the weekend.  I don't know what they are doing, but I can't see them saving for retirement.

My number one goal is retirement savings and then there is everything else....

great article....people need to wake up !

Financialmentor
Financialmentor moderator

 @NoDeliveryPizza Thanks for buying and commenting about the book. I'm glad you liked it. I'm also glad you brought focus to my comments about poverty consciousness. I was wondering if anyone would even notice. Yes, it is totally underrated and under-discussed in the literature, and yes, I plan on bringing more attention to it in the future. It is a very important issue that unfortunately blindsides a lot of people. Thanks for bringing it up in the comments.

Financialmentor
Financialmentor moderator

 @mrsmelon Yes, all U.S. citizens face that reality. It is the one risk I can't truly manage. Yes, I carry insurance, but there are still ways health care can financially wipe you out if something goes seriously wrong. It is a very bothersome risk.

rufflanding12
rufflanding12

 @mrsmelonThe quote for retirement health insurance thru my husband's company...

a HEALTHCARE company at that, is $1800.00 a MONTH!!!  Sheesh, how on earth do they expect people to pay that much?  Health insurance is expensive enough while still working, , with prices like that, it makes you want to move to Canada!

Financialmentor
Financialmentor moderator

 @mrsmelon Thanks for sharing. You bring up a great point about the health insurance problems in the U.S.  It is absolutely amazing to me how health care costs are one of the biggest financial risks we carry and accounts for a massive proportion of the financial setbacks and even bankruptcies in this country. A serious problem. Thanks for highlighting it.

Financialmentor
Financialmentor moderator

 @kamily Great points you are sharing. I'm sorry to hear about your setbacks, and I really appreciate how you illustrate the curve balls. John Lennon said it best, "Life is what happens while we  are busy making other plans." All you really have is your life now and you have to live it now. Thanks for illustrating how to just keep going forward and live life as best we can.

Financialmentor
Financialmentor moderator

 @rufflanding12 If you don't make it a priority it never happens. Life will always provide plenty of things to get in the way. "If it is got to be, then it is up to me."

Financialmentor
Financialmentor moderator

 @kamily I was thinking about your comments and just want to thank you again for beautifully illustrating the curve ball concept. Reflecting back on my own "retirement" nothing could be truer. It is an important and under-discussed issue.

ELPYESCRIMSON
ELPYESCRIMSON

"Poverty Conscienceness"...great term to describe a certain mindset. At age 54 and with a 7-figure savings account already, I still fear not having enough for retirement, which btw I'm hoping will be next year. (Wife can begin drawing early SS next year) The only reason I have a 7-figure acct is that I've been an extreme saver all of my life. Changing to a position of having to start to spend it will be a VERY difficult mindset to embrace. All kidding aside, I might need couselling.

Financialmentor
Financialmentor moderator

 @ELPYESCRIMSON Yes, your situation is a perfect prescription for poverty consciousness, as you correctly recognized. I know it is self-serving, but in you situation you really need my two books on retirement planning shown in the sidebar. It is less than 10 dollars total for both on Kindle and it will provide critically important information and serve as a necessary base understanding for the next stage of life you are entering. Let me know how I can help.

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