Ask the Expert
What is one of the biggest risks individuals face as they transition into retirement?
There are many risks to consider heading into retirement, and some you can control while others you simply cannot. You are unable to control the movements of the financial markets, interest rates, and health-related issues, however, you can control your spending. In our experience, one of the greatest risks during retirement, for many people, is excessive spending.
Typically, one’s spending allocation changes throughout retirement. For example, housing and transportation expenses decline with age, while medical and health-related expenses typically increase with age. At HM Payson, when running retirement cash-flow projections, we index spending to inflation until age 80, then keep them flat for the next five years before decreasing the spending rate for the last five years of retirement (assuming a life expectancy of 90).
Having a clear understanding of your sources of cash (Social Security, pension income, portfolio distributions, etc.) as well as uses of cash (mortgage, taxes, insurance, etc.) remains critical as you head into and progress through your retirement years. An important aspect of retirement budgeting is keeping your fixed expenses, like mortgages, low, which allows for greater flexibility in managing unexpected expenses and adjusting your spending during the inevitable market downturns. We recommend reducing large fixed expenses before retirement and to consider your financial priorities (e.g., smaller house but larger travel budget or larger house but less traveling) and to understand the related financial trade-offs.
Protect yourself from retirement risks by:
Reducing large fixed expenses (mortgage) before heading into retirement.
Establishing and maintaining an adequate emergency fund to cover unexpected large expenses.
Funding future known large expenses (European vacation) with a disciplined savings plan or by earmarking portfolio assets that will mature in time to cover the liability.
For all of our clients, not just retirees, we recommend building up and maintaining emergency funds adequate enough to cover unexpected large expenses. In addition to the emergency fund, it is prudent to establish a savings plan or identify portfolio assets (cash and short-term bonds) to pay for your known large future expenses such as a new car every four years or the family trip to Europe next summer. Having an asset/liability matching plan in place to cover these expenses ahead of time reduces the potential for unfavorable market timing by having to liquidate high-quality equities at depressed values. Imagine having to sell equities in March of 2009 (the bottom of the financial crisis) to raise cash in order to replace your car (a rapidly depreciating asset), only to see the market appreciate over 40% by the end of that year.
At HM Payson, we work very closely with clients to clearly identify their sources and uses of cash and run projections that provide the information required for them to make critical decisions about trade-offs and compromises they may need to consider in their retirement years, and to clearly identify and rank their priorities. Establishing and monitoring this plan on an ongoing basis allows clients to feel comfortable and confident as they enjoy their retirement years.