Posted by: drdata921 | August 10, 2013

For Retirement Planning, the Only Certainty is Uncertainty

BLOG CORRECTION: For those who have read the blog post on how to estimate your lifespan, there was an error in one of the links. The link that should take you to the Dr. Thomas Perl site was wrong and took you to a lookalike page. This link has been corrected in the original post, but here it is for your convenience:

http://livingto100.com

Let’s start out this discussion with a simple exercise. Think back, if you can, over the past 30 years. What has happened over this period of time? We have had both good times and bad times in the economy and the stock market. The geopolitical environment has been in rapid flux with the emergence of China and several eastern bloc countries. We have also seen the mighty fall as in the case of Greece, Italy and some would argue the UK. Global warming has become a reality that has clear implications for the lives of each of us. And finally, technology has exploded. The year 2013 looks nothing at all like 1983.

Even though many of these things are playing out on a global stage, they have clear implications for each of us in terms of our lifestyles and our finances. So, why do I bring this up? Because many of us will soon be entering the retirement phase of our lives that could easily go on for 30 years or more. Does anyone truly believe that the next thirty years will be any calmer, more predictable, or less impactful on our lives than the last 30 years? Retirement planning, because of all of this uncertainty, is complex and unpredictable. Anyone who puts this whole process on autopilot is making a big mistake because nothing stays the same.

So how do you deal with a situation that is this unpredictable? I would suggest a couple of things:

1) Don’t put retirement on autopilot. Be vigilant of the things than can affect you. Above all, you need to be flexible. If global warming causes drought conditions that increase food prices, how will you adjust your spending to compensate? Maybe you start a vegetable garden or get more creative in the recipes you use. If the stock market becomes more volatile, how will you shift your investment strategy to protect your retirement saving? If inflation, in the future, becomes a huge issue, how will you adjust your spending to ensure that you will have enough money to fund the duration of your retirement (despite rising costs)?

2) Plan for the uncertainty. Now to some of you, this is going to sound like a contradiction. If something is volatile and unpredictable, how could you possibly plan for it? Well, it is not like day one of your retirement is when the world begins. Many of the things that are likely to happen in the next 30 years have probably happened, in some form or another, previously. How did people deal with it then? What has been written that can help you develop a coping strategy. This is where vigilance is important? If you see some issues starting to bubble up on the horizon, plan for it now. Don’t wait until the wave crashes to figure out what you are going to do!

From a retirement financial perspective, incorporate uncertainty into your assessment of whether you have enough money to retire. One way that financial planners do this is to use “Monte Carlo” techniques in their assessments. What, you may ask, is this? Well Monte Carlo is a statistical procedure that has been used for several decades to deal with variation and volatility. When you ask the question about whether you have enough money to retire, a typical financial calculator will come back with some estimate of how many years you savings will last given the assumptions that you enter into the calculator. For example, it may come back and tell you that your money will last for 25 years. However, some of the key inputs, such as investment returns on your savings or inflation can vary considerably year-to-year. If you get these inputs wrong (and you probably will), the answer will be wrong. Monte Carlo techniques take this volatility into account based on historical variation. Rather than giving you a specific number of years that your savings will last, it changes the question to the probability that your savings will last for various time periods. So, what is the probability that your savings will last for 20 years, for 25 years, or for 30 years?

While the past is not always a good indicator of what you can expect in the future, it is the best estimate that you have of what to expect. So, incorporate past volatility and variation into your plans. However (and this is critical), update, update, update. You can’t do your planning once and forget it. You need to change you assumptions and re-estimate as conditions “on the ground change.” This allows you to adjust.

So, realize that there will be uncertainty during your retirement years, but don’t be unduly flustered by it. You have made it this far. I am sure that you will navigate retirement just fine. I will leave you with the sage advice of two historical figures smarter than I to point the way:

He who fails to plan is planning to fail.
Sir Winston Churchill – English Leader

Uncertainty and mystery are energies of life. Don’t let them scare you unduly, for they keep boredom at bay and spark creativity.
R. I. Fitzhenry – Businessman & Publisher

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