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Making sure retirement savings last a lifetime becomes increasingly tricky as average lifespans lengthen.
In my view, making your money last can largely be boiled down to five key levers. Three are always unknown: investment returns, inflation and longevity. Unfortunately, current conditions further complicate these unknowns. With stock market valuations at relatively high levels, investment returns may be disappointing in the years ahead. Moreover, inflation may be impacted by growing uncertainties in health care, and longevity continues to rise, especially for the affluent.
To make your money last, focus on these two levers: working longer and managing your spending.
Unlike the three levers discussed previously, you can largely control these two. Working longer can have two positive effects: adding to your savings, while not taking distributions from your portfolio for living expenses.
Of course, while it can be difficult to extend the length of your career, every year you work can have a big impact on making your money last. The most powerful lever is to manage your spending. This can involve difficult choices, but if you can control your spending, you can usually make your money last.
I view the challenge of how to make your money last as a seven-step process. Let’s touch on each of these briefly:
- Plan your retirement. Examine your priorities. What do you want out of your remaining years? Does your spending reflect those priorities?
- Create a financial plan. Fit your priorities into a financial plan, and make sure the costs fit.
- Determine your portfolio allocation. Use your financial plan to set your target investment return. Select an asset allocation that can generate your target return and fit with your risk tolerance and time horizon.
- Invest with a low-cost investment strategy. Use traditional exchange-traded funds to keep costs low and taxes low, with global diversification. Don’t get talked into high-priced products. Remember that costs generally don’t add value; they directly reduce your returns.
- Manage long-term portfolio risk. Avoid emotional trading. Maintain your asset allocation by trimming positions after major rallies and capitalizing on significant market declines to buy securities at bargain prices. This is what I call opportunistic rebalancing.
- Calculate portfolio withdrawals. Don’t trust this to back-of-the-envelope guesses; it’s too important. Many people use the 4 percent standard withdrawal rule, but that may not fit your personal situation. Instead, use high-quality software to determine your portfolio withdrawals. Beware of easy-to-use apps. If it’s easy to use, chances are the software is making a lot of assumptions, some of which may not fit your case.
- Monitor, revisit and update. Monitor your progress, update and revisit to keep on track. Be sure to check each year whether you’re on track, and make adjustments as needed.