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A Tale of Two Retirement Planning Approaches

Have you looked into financial advisory services for your retirement plan recently?  On one hand you may have been presented a "Probability of Success" analysis.  On the other hand you may have been presented with "Spending Guardrails" planning approach.  So what is the difference between these two approaches and which one is best for you?

As usual, it all depends.  If you are in early to mid career and in the wealth accumulation stage, it makes some sense to look at how to accumulate a nest egg over time and then estimate the probability of success of that nest egg lasting throughout your retirement time horizon, usually about 30 years after you retire.

If you are very close to retirement (within 5 years or so) or just starting your retirement, then it makes some sense to look at your retirement plan as an income strategy to meet your monthly spending needs.  Knowing how much you can reasonably spend per month is usually a better approach than probability of success at this time in your life.

The simple comparison is that wealth accumulation sets your retirement stage, while wealth distribution ensures a sustainable retirement income.  The first utilizes a Probability of Success analysis and the second utilizes a Spending Guardrails analysis.  Combining both strategies can lead to a more robust and adaptable retirement plan.  Read on for a more detail discussion of each approach.

Wealth Accumulation

The first phase of building your retirement nest egg occurs as soon as you start to save from your paycheck and continues until your very last paycheck. Generally, that is between the ages of 25 and your retirement age, generally around 65. 

During the accumulation phase, most people will save into a 401(k) or an IRA in some mix of stocks, bonds, mutual funds, or ETFs.  Saving 15% of your paycheck can yield a significant portfolio by the time you reach retirement age, as the graph at left shows.

This is a basic financial planning and retirement planning strategy to obtain wealth.  

Client Centered

Probability of Success

There are a couple key analytic points to understand in the wealth accumulation phase.  One is Probability of Success or PoS.

Generally, advisors will run a Monte Carlo simulation of how your asset pool will grow over time given (usually) a thousand iterations/variations of stock market performance.  That output is presented as a PoS that your asset pool will last throughout your retirement time horizon.

Client Centered

Project When Assets Run Out

Another key analytic point to consider is when the asset pool will run out.  Generally, we use longevity to be about 95 years.  In the wealth accumulation phase, the analysis is a very rough estimate on how long assets will last.

The graph shows the accumulation phase from age 25 through retirement date.  Then the curve drops sharply during retirement until the asset pool is exhausted. 

There is myriad of factors that affect this analysis and it's critical to see your financial professional at least yearly to review any trends.

Wealth Distribution

The distribution or de- accumulation phase begins on the date of retirement and lasts throughout the retirement horizon. Generally, I use the age of 95 for planning purposes unless there is a significant reason not to, such as a diagnosed illness. People, in general, are living longer due to medical advancements and if you are reasonably healthy at age 65, then you have a very good chance of living until age 95.

Instead of accumulating wealth, the challenge is to distribute your nest egg into a retirement income stream to augment Social Security and other guaranteed income streams you may have, to meet your retirement lifestyle objectives.  Take out too much from the portfolio and you could run out of money too soon, before you pass.  Take out too little and you may not live your retirement years to their fullest.

The analysis point here is to set up Spending Guardrails so that you know a range of spending that can incur from your asset pool.  Generally, this give a better indication of how you can meet your monthly spending needs rather than just relying on a Probability of Success analysis.

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Spending Guardrails 

Rather than relying on fixed withdrawal percentages (like the 4% rule), this strategy adjusts annual distributions based on market performance and inflation.

The guardrails are are upper and lower bounds for spending.  If a guardrail is reached, then spending is recalibrated to maintain the initial targets.

Setting guardrails allow for real-time adjustments to your Retirement Plan based on real-time market conditions.

Either One or Both

Whether you benefit from either Retirement Planning approach or both as a hybrid approach will depend upon your personal situation and desired outcome from your Retirement Plan.  

The key is to make any savings or income strategy adjustments as early as possible.  The perfect time is right now.  It's never too early to start planning!

How We Can Help

The 5-10 years prior to you taking retirement is the best time to plan for your retirement.  Doing so may help you avoid some unpleasant surprises.  

Our services are focused on both the accumulation phase of retirment planning and the de-accumulation phase.  

Our primary objective is to help you formulate a Plan that will provide you the income to last you throughout your retirement horizon. the best time to start planning for the de- accumulation phase is 5- 10 years prior to the date you plan to retire, what we call the transition phase. Then you will have some time to make any adjustments necessary prior to your retirement date.  This is when we can "Help You Visualize Your Retirement Possibilities."

Even if you are on the cusp or early years of your retirement, we can provide better clarity of the remaining retirement time horizon.

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If you believe you could benefit from working with a fiduciary financial planner that specializes in Retirement Planning, let’s get a conversation going to see if you’re a good match for our practice.