Weekly Observations for 5/25/2018 — Inflation and a Simple Retirement

We’re about to kick-off a lovely three-day weekend…enjoy it! Before I go, there are a few items that came up in client conversations this week that I think might be of interest to you.

As you may know, Patrick and I raised our forward-looking inflation assumptions for financial planning last year — acknowledging that the ultra-low inflation of the past decade is unlikely to persist for the next decade or longer.

A number of our colleagues have also spotted rising inflation in underlying corporate data recently — a trend that is confirmed by the tight labor market and rising wages. And the Federal Reserve indicated this week that they plan to let inflation run above their target for some period. For the most recent 1-year period, inflation was 2.5%.

There are a number of risks we face as investors preparing for retirement, and inflation is chief among them. If inflation is high during retirement, the challenge of maintaining your lifestyle as costs rise requires careful attention to portfolio structure and spending rates. The challenge is even greater if part of your retirement income is from a pension that doesn’t include inflation adjustments — although it’s not an insurmountable problem. Maintaining a stable income stream with laddered bonds, paired with an investment mix that includes inflation protection, works wonders.

To address this for clients, Patrick and I are pretty astute at running and analyzing even the most complex retirement cash flow scenarios, and we pride ourselves on being able to distill 100 pages of statistical probabilities and analysis into a two-page client executive summary with a simple percentage indicator of your retirement safety.

But at the end of the meeting, most clients just want to know two things — Am I okay? and How much can I withdraw each year?

Life isn’t quite that simple, but the challenge is accepted. So is here a framework we can use for a simple retirement assessment.

Let’s say you are retiring with $3 million in the bank. For this analysis, we’ll leave it in cash earning 0%, but there is also no risk that the value will decline if the market drops. Since your retirement could be as long as 40 years, simply divide $3,000,000 by 40 years and it turns out you can withdraw $75,000 from your account every year to live for 40 years. Not bad!

Of course, that doesn’t account for inflation since $75,000 in 40 years will only buy you about $17,000 worth of food and care.

So we’ll need a framework that will allow $75,000 withdrawals to inflate each year, reaching $325,000 per year in 40 years (hard to imagine, but true).

I’ll have more on this simple retirement assessment in the coming weeks. For now, take a moment to calculate your nest-egg annual withdrawal by dividing the balance by the number of years you’ll live in retirement. Is it enough? Once we address the inflation problem, it just might be.

More next week…

Have a happy Memorial Day weekend!
Kenneth