Just when things are humming along nicely, the stock market reminds us that they are in charge. The coronavirus has spooked the market and people are on edge. Oil prices have plummeted, companies are warning of lower earnings, volatility has returned, and people are fearful. Let’s not forget the market had it’s quickest move into correction territory ever.
And what does all this mean? Nearly everything I’ve just mentioned above are things we can’t control. Because of this, it sounds like a good time to focus on things we do control. So let’s run a simulation on our expected retirement expenses and cashflow.
The interesting thing about forecasted simulations, the degree of accuracy is hard to measure. This is especially true for expenses. When I ran these numbers, everything looked healthy and I felt good about the result.
The issue is I’m not sure of the level of confidence I have, again, especially with the expenses. Since I’m still 5 years away many things can change but things will change in 25 years too so it’ll never be 100% accurate.
The comforting part of expenses is that a significant percentage is flexible. If necessary, I can imagine that nearly 50-60% of my expenses can be classified as “flexible.” This means that if I have an unexpected high expense one year or if the market completely sours, then I have the ability to reduce expenses quickly.
And another comforting feeling is that a significant part of my income is non-portfolio related. This means social security, pensions, retiree healthcare benefit could handle most of my fixed (non-flexible) living expenses.
Forecasted Expenses
Forecasting expenses is difficult, especially healthcare. In the USA, healthcare and the battle to bring affordable care is making it hard to predict costs. In this forecast, we show nearly $800,000 spent in healthcare from age 62-90 and this doesn’t include long-term care.
I’d almost be that we won’t spend that much on healthcare but who really knows. I’m not sure if this is correct but I’d rather over forecast than miss the mark completely. Fidelity predicts that a post-65 year old couple will pay about $285,000 in healthcare so it’s very likely I’m way over forecast.
Again, we can flex over 50% of these expenses (i.e. travel, gifts, etc…) in a pinch. I’ve shown a peak of total expenses at 80 years old and then they slowly reduce.
Travel drops a lot after 80 years old but it is replaced by a rising “gift” category. I’m predicting I’ll be more generous as I get older, especially with the kids.
Most of these categories have some inflation increase built into them. Of course, the house will be paid off but you still have taxes, insurance, utilities, and overall upkeep. Thank goodness we live in a low real estate tax state. In August 2019, I determined that living in a house would be better than buying a condo or renting … as least for our situation.
I write about tracking your expenses all the time. Using that information enables me to at least try to forecast my retirement expenses. It always amazed when somebody retires but they have no idea what their expenses will be. That seems like a risky “hope for the best” attempt at retiring.
The comforting part of this exercise is that if we hit a rough patch of high expenses, we can reduce some discretionary (flexible) costs. Things like travel and gifts can be eliminated or reduced, if necessary. That’s not the plan but cutting out $30,000 of expenses quickly provides the flexibility you need in retirement.
Forecasted Income
As important as knowing your expenses are to retirement, it’s also critical to know all sources of incoming cashflow. A great first step is knowing what sources will create an income floor. Any expenses above your income floor will need to be covered from your portfolio.
My non-qualified 401(k) is really a part of my savings but the conditions of the investment make it an automatic payout. Once I retire, my company will payout the “bond” over 5 years. If I add nothing more to the account, I’ll likely see about $35,000 each year for 5 years.
In this simulation, I consider taking my social security at 67 years old. I’m sure I’ll run another simulation by taking it at 70. Even with the high expenses, almost every year I’m having to pull something from my portfolio.
But here’s the important observation. Even after pulling from the portfolio almost every year, the balance is always up. And let’s not forget nearly 50% of my expenses are flexible plus I’m likely over forecasting the healthcare costs. My net retirement cashflow should be in good shape.
The trick to running these simulations is being conservative. For example, I’m only applying a 3.5% total return on the portfolio each year. I’m fairly confident that my portfolio will gain more than 3.5%. This 3.5% return means I could have a portfolio balance of $2,558,566 at 90 years of age.
If I received a 5% total return, the balance at 90 years old will be around $4,000,000. This would make me much happier but I’m staying conservative. If the 5% happens then that’s great but I’m not going to count on it.
I’m running these simulations for one purpose, to determine if I will run out of money given my forecasted expenses? Nearly every number will be wrong but you have to forecast to see if you even have a chance.
There’s no doubt that I’ll run another 1,000 simulations in the next few years. Even if they all come out positive, I’ll still be concerned about running out of money. Isn’t that retirees do?
Summary
When the stock market is volatile, it’s a good time to stay focused things you can control. And it’s a good time to focus on expenses and to understand your cashflow in retirement.
After running this exercise, I’m fairly confident that my finances will be fine. It’s comforting to know I’ll have flexibility with nearly 50% of the expenses. Plus, I know my retirement income floor well over $100,000 when I start taking social security.
I control my savings rate, investing in high quality investments, and my emotions during volatile times. I control the creation and execution of a retirement plan.
Thanks for reading!
Mr. TLR