You know what happens when you assume…
It is said that you should never assume because it will cause you to make an @$$ of U and ME. While the origin of this phrase is a bit clouded, it is widely attributed to the television show, The Odd Couple. Hopefully that isn’t actually true, because when you are a financial planner, you are in the business of making assumptions.
The key assumptions planners make every day are: how long someone will live, the expected returns of an investor’s portfolio, the inflation rate and how fast they will spend their money. Everything else is just arithmetic.
I recently woke up to a piece on the radio from a “leading financial planner” in the area. He said that the typical person readying for retirement should plan to live to be 95 years old and people under the age of about 35 should plan to live to be 100 years old. So far so good. Then he said that while inflation has run about 2% recently, 3% is probably a more conservative and historically correct estimate for the rate of inflation. So far still so good.
Then he surprised me. He said that a reasonable estimate for a retirement portfolio would be a return of between 5% and 5.5%! If he believes that, I would love to see the arithmetic this planner shows his clients. I ran an analysis with those assumptions and included a 1% advisor fee (this advisor’s fee on the first $1 million invested with his firm). Applying the arithmetic to his assumptions, starting with a 5% annual withdrawal rate at the age of 65 (plus annual cost of living increases), you go broke at age 87.
Some might say that a 5% initial withdrawal rate is too high and bring up the so-called “4% rule” that suggests an investor should only take out 4% of assets initially. That definitely improves the situation. You go broke at 95 instead of age 87. At least you make it to age 95, but it’s not very reassuring if you are younger and planning to live to be 100. And keep in mind, the original research on the so-called 4% rule pointed out that if you followed the rule, you would virtually never go bankrupt. Your worry wasn’t supposed to be about running out of money. It was about how much you would leave to your heirs.
Some advisors now are starting to recommend the “3% Rule”. Anybody recommending the “3% Rule” should simply hang up their hat and get out of the business. Why on earth would anyone need to follow a 3% rule? You could simply divide your assets into 33 equal parts, invest it in a ladder of Treasury inflation protected bonds and you have a guaranteed steady stream of income for the next 33 years including inflation. Granted, you give up the possibility of excess returns, so maybe you are leaving some money on the table and from a planning perspective it’s not a very flexible way to manage your money. But in theory, you end up in the same place as what your advisor is telling you – broke. Although in this scenario at least you don’t go broke until age 98 – that’s pretty good no matter what age you are. The only reason to adopt a 3% strategy while using an advisor is so that your advisor has a steady stream of income!
You have to assume to plan for your retirement. It won’t make you an ass. It’s part of the process. But if you take advice from the guru on the radio, sometime around the age of 87 you won’t assume you have a pain in the @$$. The pain will be real and it will be coming from your (empty) wallet.