Chalk Talk: Income Planning




Welcome to this week’s Chalk Talk. This week we’re talking about income planning and today I’m going to share a big mistake that we see people making all the time with their income planning. This is the mistake or a type of mistake that can make or break your retirement.


Now, for what it’s worth, I will be honest with you, most people we see making this mistake, yeah, they’re engineers. Engineers that love spread sheets, these are the guys making this mistake all the time. But you know what? It’s not just them. It’s really a lot of us as we just think about our retirement planning. So let me give you an example here on the board of what I’m talking about. So the other day, in fact this happens pretty much every week, I get someone or we get someone coming in who is an engineer that loves spreadsheets and by the way, nobody loves spreadsheets like I do. I love those spreadsheets. By the way, here’s what they’ll do with their retirement planning. They’ll come and they’ll say, “Oh, here we’ve done the math, got the spreadsheet out. We’ve saved a million dollars for retirement.” Now, by the way at home, you may have saved more than that, you may save less than that. The amount doesn’t matter.


They say, “I’ve saved a million dollars. So here’s my inputs. I’m expecting that I’m going to earn about 7% a year and I expect to distribute or take out for income 5% a year.” So, in other words, earn seven, take out five. That should be good, right? “And I expect to be retired … I’ll live about 20 years.” And they’ll show me their spreadsheet and they’ll show me the math. And on the math they say, “When you take all of this into account, all into account,” they say, “I got a million today. I expect by the time I die 20 years from now I’m going to have somewhere around 1.5 million that I leave to my family.” And everything should be good, right? Looks pretty good to me. Earn seven, take out five. You take out less than you earn. How could that possibly go wrong? What could possibly go wrong here? This looks good. What do you need me for? Right?


But herein lies the mistake that so many people make with their retirement planning. They’re using what I call static returns versus dynamic returns. Static versus dynamic, what does that mean? Well, here’s what it means. Right here. Here’s what I know. See that 5% number. Yeah, they’re going to take that out every year. That we know. And it’s going to be the same number they take out every year. So that’s fine to be static, meaning the same every year. But what about that number? You tell me. When’s the last time you earned exactly 7% as a return in your portfolio, and then you earned it again the next year, 7% the next year and 7% the next year and 7 … When’s the last time you’ve earned the exact same return, 7%, every single year in your portfolio? When have you done that? Yeah, the answer is never. Because how does it really work?


Well, “Hey, I got 20% this year,” and “Oh, I got 3% that year,” and “Uh oh, there’s a plus 15, but wait, there’s a minus 12.” In other words, you get some positive years, you get some negative years. They’re all over the place. They’re all over the place. In fact, if I were to go back in time and look at the last 20 years on somebody like this, at the end of 20 years they wouldn’t have 1.5 million. They might have about 370K. Why? It has to do with something called order of returns or sequence of returns risk. And all that means is that 7% doesn’t come all at the same time. Sometimes you have good years, sometimes you have bad years. And the reality is if the bad years happen at the wrong time, it totally messes up your planning. Completely screws it up. So instead of using static returns, “I’m going to earn 7% per year every year,” instead, when it comes to your retirement income planning, you want to use dynamic returns and specifically you’re going to be using some kind of probability analysis.


In other words, what you really should be asking yourself is the following. “Given that I’m not going to earn 7% every year,” that it’s going to be all over the place, you want to ask yourself the question, “What is the probability that this is going to all work out for me? Is it 50%? Is it 90%?” Where is that probability? And your job, our job as retirement specialists is to help you make that probability that this is going to all work out as high as possible. No sure things in this world. It’s dynamic. Have a probability analysis done.

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Centennial Advisors