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How to Plan When You Don’t Know Your Goals

Defining one’s goals isn’t easy for some people. Trying to envision what your life will look like at some point in the future can be difficult.  There are so many emotional and financial variables and so many unknowns in life that it can leave you feeling stuck or in a holding pattern until you find clarity.  We know that because it is a relatively common issue that we run into with our clients and an issue we try to help resolve for them. Retirements, illness, or the death of a family member can be very disruptive.

We help clients find clarity by trying to quantify the financial impacts of their situation and model other scenarios they are considering.

To illustrate what we do, let’s consider a typical client situation.  A couple with two college-age children have come to us looking for guidance in planning for their future.  They have very good incomes and a vacation property, but there expenses are high and they have not saved as much as they should have in the past.

Here is our process to help get this client out of their holding pattern:

  1.  We model their current financial situation and extrapolate those results out through their retirement.  Every conceivable financial variable is used to model the current situation: income expenses, accounts, assets, social security, etc.  The result is some perspective on the likelihood of maintaining the current lifestyle assuming nothing changes.  The model is summarized in a simple graphic, an example of which is below.
  2. The graphic above is presented to the client. The big circled number at the top provides a probability of success for the client to reach their financial goals.  The calculation uses Monte Carlo Simulations to imagine sequence of returns risk.  Basically, the model runs 1000 simulations to imagine how rates of returns affect a client reaching his goals.  What happens if there is a big recession early in retirement?  What happens if there is a big recession later in retirement?  What happens if the markets are flat for several years?  These are all scenarios that are modeled and considered and shows that of the 1000 simulations, 77%  result in their goals being met:
  3. In the first example above, it shows that their annual savings of $27,500 is used to successfully fund college education for two children as evident by the two green bars.  But it comes at an expense -their retirement is not fully funded as seen by the yellow bar.  This is where the conversation begins.
  4. We can begin to model changes on the fly to see how certain changes will affect their future in retirement.  In this example, the client has been wondering if they should sell their vacation property and use the savings for retirement.  We can quickly quantify the long term impact of that decision:
  5. Then we can see how that change will affect the probability of success.  We can see below that by making this one change, we have increased the probability of success from 77% to 93%.
  6. Sometimes, this gives the client enough clarity to make a decision and move on.  But that’s not always the case.  After the client has thought about making a major decision (such as selling a vacation home), they may come back saying they can not actually sell their vacation property and need to consider other options.  Below is a comparison of their current situation compared to a scenario in which they delay retirement for two more years.  The result is almost the same as if they sold the vacation property.

After this exercise, the client has two viable options to consider to get them on track for retirement.  By seeing certain scenarios modeled, it can make possible decision more real to them and hopefully more achievable.  The illustration we provide help them make better decisions.

There are lots of emotional decisions that revolve around major life decisions, like retiring, changing jobs/careers, and moving.  We believe that by addressing the financial impacts of these decisions, we can affect the emotional considerations that may be holding our clients back.  Our goal is to provide that nudge to get them moving in the right direction and to keep them from making mistakes.

If you feel like you are stuck or need help laying a clear path forward, please reach out to us:

 

Effects of Saving an Extra $20 Each Week

Saving just a little bit extra each year can have a profound impact over the long term.  Investor’s Business Daily ran some pretty interesting numbers showing the impact on one’s retirement if an extra $20 is saved every week.  Here is some of the findings based on certain age ranges:

Recent College Grad: invest $20/wk earning 6% and by retirement, that pot of money will be about $330,000.

Someone in their mid-40s:  invest $20/wk earning 6% and by retirement, that pot of money will be about $40,000.

Someone in their mid-50s:  invest $20/wk earning 6% and by retirement, that pot of money will be about $14,000.

The results are pretty clear – consistently investing over many decades can have exponential benefits on your financial situation.  Even small amounts can add up to have a big impact when time is on your side.

 

 

A $200,000 Mistake

In early 2016, the stock market experienced a 10% market correction in a matter of a few weeks.  It resulted in a few phone calls from clients wondering if they should move to cash.  One conversation with a recent retiree really stood out for me and I wanted to share an abbreviated version of it with my readers:

Client:  At the start of the year, I had $1 million invested in the market.  But now it’s February and I’ve lost $100k. We’ve got to stop these losses.  Please sell me out of everything and put me into cash.

Me: Would you consider staying the course a while longer?  As quickly as the market can decline, it can increase just as fast.

Client: Thank you, but I still want to move to cash.

Me: How about we sell 10% of the total value of the account?  That will cover your distributions for the next two to three years.

Client:  No thank you.  I want to be in cash now.

Me: Just one last idea – how about we move 50% of the account into cash?  That will cover your distributions for 10 years.  And in ten years, you can tap into your investments for your future distributions.

Client:  Look, I rode out the 2008 and 2009 recession and I don’t want to have to do it again.  I’d rather keep it in the bank and not have to worry about the stock market.

Me:  Ok, I’ll sell everything today.

 

There is a lot to process in this conversation.  First, the client called up believing they lost money.  Between the start of the year and the day the client called, the account had declined about 10%.  The sketch below shows how he visualized the loss.

From a behavioral finance perspective, the client anchored his thinking to the high point in their portfolio.  It became his frame of reference, his point of comparison. But if we looked backward and used a different reference point the story changes.  We would see that his account balance is right where it was 12 months earlier:

The idea of anchoring to a high point is a common issue that behavioral economists study.  We, as humans, sometimes make irrational decisions.  We make decisions that we believe to be based on objective facts, but are in reality detriments in how we try to solve problems.  I tried to reframe this particular client’s thinking a few different times but was unsuccessful.

Recently, I went back and reviewed this client’s portfolio to see how he would have done if he stayed the course.  As we know, the market ended up recovering and ended the year up about 10%!

The day the client called wanting to sell out of the market ended up being the very bottom of the market “correction”. For the rest of the year, the stock market recovered from its lows in February and then began to reach new highs by the end of the year.  Unfortunately, that client stayed in cash for the rest of the year.  It has resulted in a $200,000 mistake!

That red circle in the sketch above represents a behavior gap.  This is a well documented phenomenon in which investor decisions and behaviors are dragging down their portfolio performance (Morningstar). In this case, it could have been completely avoided or at least significantly minimized.  The quick reaction to move to cash will have a lasting impact on this client, but he probably won’t notice it until his cash balance is drawn down substantially.

This serves as an example for investors to stick to their plan and avoid making sudden and drastic changes to their investment strategy… and to listen to alternative suggestions from their advisor.

Move Over Florida, There is a New Retirement Hot Spot

Florida may not be the ideal location for retirement according to some new research from Bankrate. Based on tax rates, crime states, weather and health care, Bankrate has ranked all fifty states to find the best ones for retirees. Florida ranks 17th! Connecticut comes in 32nd

New England has two states that make the top of the list. New Hampshire claims the top spot and Maine claims the third spot. Surprised? I am too. I guess Bankrate didn’t factor in cold weather as Minnesota and Colorado also made the top 5.

See the full list

Alternative Retirement Examples (Millennials, this one is for you)

Ask a 20 or 30 something about their vision of retirement and they often shrug.  They can barely make ends meet now – how can they try to envision themselves in 40 years?  Conventional wisdom suggests that they should save as much as they can.  If they save enough, they might be able to retire early!  Soon, that conventional wisdom will be labeled as outdated.  It does not reflect the changing situation of current retirees and especially the mindset of Millennials who value work life balance much more so than other recent generations.

This post will explore some of the more creative ways someone can retire.

  • Semi-retirement.  Currently, the most popular alternative.  This approach suggests that someone could retire in their mid 50s and work part time doing a fun job until they are ready for full retirement.  This is a very common option for many of our clients who have started consulting businesses or have turned a hobby into a side job. In many cases, these semi-retired individuals are working well into their 70s doing something they love.
  • Our traditional view of working one career for 45 years may be changing.  A very small but rising trend is to take a 4-5 year sabbatical every 15 years of working a full time job.  In this case, the individual is enjoying “retirement years” much earlier in life. Working years are broken into three 15 year full time chunks of time and are sometimes delineated by different careers each time.  Perhaps, someone takes a few years off to get an advanced degree and reenters the workforce as a consultant or as a teacher.
  • Short Sabbaticals.  An alternative to the above is to take a year every ten years and work on a reduced schedule.  This gives the individual flexibility to travel or do something they love without having to give up their career.
  • Extreme Retirement.  This is the traditional retirement approach taken to an extreme.  In this case, the individual (or couple) in their late 20’s or 30s is saving 70% of their income every year with the hopes of retiring in their 40s.  They are taking frugality to the highest level and this concept is starting to turn into a movement.

In all of these cases, planning becomes crucial.  The status que and conventional wisdom is tossed out the window and is replaced with a truly customized plan for the individual.  If any of these options resonate with you (or someone you know) make sure a financial planner is engaged early in the process to ensure the right plan is in place.

A little bit of forethought early in one’s life mixed with the correct planning can have a tremendous impact on one’s life.

What Happens When Your Retirement Plan Goes Awry

US News recently made several good points in the following article: When You Do Everything Right But Your Retirement Plans Go Wrong

I would add that a financial plan should be reviewed on a regular basis regardless of what’s occurring in the market.  The analogy we use is that a financial plan is similar to sailing a ship across the ocean.  Throughout the journey, there are many course corrections along the way.  It’s to be expected and the plan must be dynamic enough to adjust.  In some cases, investors believe that a financial plan is static and that it never changes.  It’s important to remember that a plan is good for only as long as the underlying assumptions remain valid.  If inflation increases too much or if the markets are negative for an extended period of time or some other assumption changes, it may warrant a change in the plan.