Retirement Planning: Focus on the Critical Variables within Your Control

A generation ago, it was relatively easy to make your money last through your lifetime: You retired at 65, bought bonds, and lived off your pension and Social Security.  You weren’t expecting to live much past age 75.

Things have changed. Interest rates are near historic lows, pensions are rare, Social Security hasn’t kept pace with cost of living increases, and longevity is rising.

Making your money last will likely be the single greatest financial challenge you will face.

Too Many People Focus on the Wrong Factors

Generally, there are five financial planning levers which decide your ability to make your money last:

• How much you spend
• How long you work
• Investment Returns
• Inflation
• Longevity

Three of the five are largely out of your control: investment returns, inflation, and longevity.  Today’s environment makes these three variables difficult even to model.  Current stock market valuations and historically low-interest rates may reduce investment returns in the near future, inflation may be affected by uncertainties in the healthcare market, and lifespans are longer than ever.  That means you may need to plan to make your money last until age 95 or longer, depending on your health and family history.

Unfortunately, too many people focus on the wrong (i.e. uncontrollable) factors when they try to make their money last.  They primarily focus on investment returns, which are important, of course.  But the reality is that you have relatively little control over returns, outside of managing your asset allocation.  Ironically, if you try to beat the market, you’re much more likely to underperform it, and that’s a very effective way to not make your money last.  It’s easy to underperform the market and beating the market is oftentimes a matter of luck, and that’s not something on which to base your future.

Focus on Levers You Can Control

But you have two important levers at your disposal that you can usually control:

• How long you work
• How much you spend 

It’s amazing to understand the impact these two variables have on retirement plans. The length of your work career has a double-barreled effect on making your money last.  Working longer extends the positive cash coming into your investments; at the same time, it reduces or eliminates the need to take portfolio withdrawals and collect Social Security during those years.  The accompanying graphic produced by T Rowe Price illustrates this.  For example, delaying retirement from age 62 to 65 – even without any additional savings during those years – will result in an estimated ~20% increase in income annually throughout your retirement.

Spending usually has the biggest impact on a financial plan. Even a relatively modest reduction in spending can have a huge effect on making your money last.  The reason? Long-term cuts in expenses have long-term impacts that really add up over time – it’s the consistency of the spending cuts that make controlling spending such an effective lever.

Troubleshooting Your Financial Plan

If your financial plan isn’t quite working out, spending less is your best way to get back on track.  Planning to work longer is also a good option, but one with some uncertainty. You could plan to work until into your late 60s but be forced to retire earlier for health reasons, for instance.

Sure, it’s more fun to try and boost your investment returns, but the goal of investing is to make your money last and that requires discipline. Rather, focus your energy on what you can control.  Specifically, your spending and when you stop working and transition into retirement.