There have been decades where stocks provided outstanding returns and decades where the returns were about the same as what you would get if you had stuck with safe investments. There is no way to know exactly what rate of return you will earn on your money in retirement. Basing the success of your plan only on average returns is not a good idea. An average means half the time you would have earned something below average. What to do: Check out historical returns by looking at both best-case and worst-case outcomes. Some 20-year time periods look great; others do not. You must make sure your plan works even if you get an outcome that is below average. You can then run scenarios showing you different options so you know what to adjust in your plan—such as spending—if you retire into a time period that delivers below-average returns. For example, suppose the first five to 10 years of your retirement, all your investments do well. In that case, not only do you have the amount you need to withdraw, but your principal balance also grows. In this situation, your chances of running out of money go down. On the other hand, if your investments do poorly in your first few years of retirement, you may need to spend some of your principal to cover your living expenses. It will be harder for your investments to recover at that point. What to do: Test your plan over numerous possible outcomes. If a poor sequence of returns occurs early in retirement, plan on making a downward adjustment to your spending and lifestyle to make sure your money lasts throughout your retirement years. Different studies put that number at anywhere from about 3% to about 6% a year, depending on how your money is invested, what time horizon you want to plan for (30 years vs. 40 years, for example), and how (or if) you increase your withdrawals for inflation. What to do: Create a plan that calculates your anticipated withdrawal rate—not only year by year but also as measured over your entire retirement time horizon. Depending on when Social Security and pensions start, there may be some years where you need to withdraw more than others. That is OK, as long as it works when viewed in the context of a multi-year plan. Another mistake people make is spending more when investments do well early on. When you retire, if investments perform quite well your first few years of retirement, it is easy to assume that means you can spend the excess gains. It doesn’t necessarily work that way. Great returns early on should be stashed away to potentially subsidize poor returns that may occur later. If you withdraw too much too soon, it may mean that 10 or 15 years down the road, your retirement plan will be in trouble. What to do: Create a retirement budget and a projection of the future path your accounts will follow. Then, monitor your retirement situation in comparison to your projection. If your plan shows that you have a surplus, only then can you spend a little more. Perhaps not as big of an impact as you may think. Research shows as people reach their later retirement years (age 75+), their spending tends to slow down in a way that offsets rising prices. In particular, spending on travel, shopping, and eating at restaurants goes down. It has been shown that inflation will have a lesser impact on higher-income households, as they spend more money on non-essentials and thus have “extras” that can be given up if inflation rates get high. Inflation has a bigger impact on lower-income households. You have to eat, consume energy, and buy basic necessities. When prices rise on these items, lower-income households don’t have as many things in their budget that they can cut out. They have to find a way to cover the necessities. What to do: Monitor spending needs and withdrawals on a year-by-year basis and make adjustments as necessary. If you are a lower-income household, consider investing in an energy-efficient home, starting a garden, or living somewhere with easy access to public transportation. These estimates come from looking at total healthcare-related spending, which includes premiums for Medicare Part B, Medigap policies, or a Medicare Advantage plan, as well as co-pays and doctor’s visits, lab work, prescriptions, and money for hearing, dental, and vision care. What to do: Take time to estimate your healthcare costs in retirement. It is better to assume they will be high and that you will have to spend your full deductible each year. If you don’t incur the expense, you are free to spend the money on something else. Planning this way leaves you room for extras. It is much better than coming up short. If you’re married, you have to account for the potential longevity of whichever one of you should live the longest rather than looking at things as if you were single. If you have a large age differential, you must think about the life expectancy of the younger of the two of you. The longer your retirement money needs to last, the more careful you need to be about monitoring it to make sure you are on track. What to do: Estimate life expectancy and put together a retirement projection, which is a year-by-year timeline of income and expenses. Extend this timeline to about age 90.
