We have to understand both the nature of plans and the nature of retirement finance before we can build a successful retirement plan.
It’s only rational to update any plan (not just retirement plans) to account for new, important information. Say that on Monday, the weather forecast for Friday is warm and sunny so we plan a day at the beach. If the weather forecast on Thursday changes to a wet and cold Friday, then we need to change our plans. It no longer matters on Thursday what conditions were last Monday.
While that no doubt sounds obvious to all of us, not everyone thinks about retirement plans that way.
As a top retirement researcher recently pointed out, “Your retirement plan is probably wrong in less than a year.” Or, to paraphrase a Prussian military commander from 1880, no plan survives initial contact with the enemy.
In retirement planning, uncertainty is the enemy.
Key retirement plan inputs can change every year. Our remaining life expectancies will decline a little less than one year for every year we survive and we’re one bad checkup away from downgrading that. It can change significantly for the better, too, as CML leukemia patients experienced with the introduction of the miracle drug, Gleevec.
We may marry, get divorced or become widowed. Our investment portfolio will likely go up or down, perhaps by a lot at times.
We may experience expense shocks or receive an unexpected inheritance or not receive an expected one. Our expectations of market returns and our risk tolerance can also change.
As I mentioned in a series of posts at The Retirement Cafe, the first step of retirement planning is to define our financial goals. Goals can change dramatically, too. A plan to pay for a grandchild’s college education might change, for instance, when she gets a full ride to her chosen college.
These are all critical inputs to a retirement plan and if they change, your plan should change along with them. Receive a large, unexpected windfall and you may want a new plan. Notice that your savings portfolio is half-depleted after the first five years of retirement and you need a new plan.
Again, this may all seem obvious but when it comes to retirement plans, some of us think, “What the heck, this plan was good enough in 2001 so it’s good enough for today!” Or, “I only need a planner when I retire and I’ll just tweak that plan for the next 30 years.” Or my favorite, “I can safely spend $35,000 this year because that was 4% of my portfolio value when I retired 20 years ago.”
We can think we understand the need to change our plan but plan in ways that belie that understanding.
Some retirees and planners who would agree this is obvious also believe they can determine a safe amount to spend throughout retirement based on their financial situation back when they first retired (the so-called 4% Rule). Liabilities don’t care how much money you used to have—that’s last Monday’s weather forecast.
They might also believe they can develop a retirement plan today that will at worst need “tweaking” from time to time. That would be a lucky coincidence, indeed. Or, that their estimate of the size of their estate 30 years from now is somehow accurate. Or, that they can know at age 65 what their asset allocation should be when they are 85. So, we can say that changing our plan to accommodate changes in our situation is obviously necessary but plan as if it isn’t.
Some important observations can be made when we accept that a rational retiree will change her plans when her goals, resources or expectations change significantly.
The first and most important observation is that retirement planning is a lifelong endeavor.
Plan updates often require more than having a planner calculate a new safe spending amount annually or rebalance your portfolio. The entire plan needs to be reviewed annually or anytime there is a significant change in your goals, resources or expectations.
The good news is that you can change many facets of your retirement plan fairly easily at any time, though some retirement decisions are essentially irreversible. It is difficult in the U.S. to un-buy annuities, for example, but easy to buy more. You can mitigate this by annuitizing in smaller chunks over time. For all practical purposes, you can’t un-claim Social Security benefits (there are limited exceptions).
You probably can’t re-enter the workforce after more than a few retired years with anywhere near your previous pay. You need to make these decisions with great care and understand their irreversible nature.
Choose to spend from an investment portfolio and you probably won’t be able to rebuild it should it become significantly depleted. You might need to take remedial action quickly to avoid a dangerous level of depletion and you often won’t be able to take it fast enough. You’ll need a new plan.
Most of the other important retirement decisions, however, can be re-made every year. You can even change your strategy. Perhaps as you get older you will become more risk-averse and trade your floor-and-upside strategy for an annuity strategy or more risk-tolerant and invest more in equities.
Being able to substantially revise your plan every year also means it’s never too late to develop a plan if you don’t have one.
Our financial circumstances, goals, and expectations can change dramatically from year to year. It’s irrational to imagine that our plans don’t need to change accordingly or that our plan’s probability of succeeding hasn’t changed.
Retirement planning is a lifelong process and your current plan may only be a good one until its next encounter with the enemy.