Tom Discusses Making Money Last for Retirement
Transcript:
Katie Nealis:
What happens if I lived past my life expectancy and my financial plan?
Tom Vaughan:
Yeah, ironies of financial planning, is if you don’t live very long, it’s pretty easy to plan for that. Because you know, it just doesn’t take that much money. And I know, we all want to live longer, especially with good health. But it’s very, very difficult to make your money last that long, you know, because inflation comes along and those types of things. So, you know, what is your life expectancy is one starting question I would have. And so, you know, we all hear these different numbers, but your life expectancy changes based on your age. So by the time you’re 94, you still have a life expectancy. And it might be, you know, 98, or 99, or what have you, but, and so what we do that for almost all the cases, unless somebody really decides they want to do something different, we plan to age 100. And it’s not so much that we expect people to live to be 100. Although we are seeing more and more of that within our practice, it is really just to kind of create a buffer for exactly what your question was, which was, what if I outlive my life expectancy, you do have to be careful here because you can put together a plan that’s bulletproof for a really long period of time. And then if you don’t really live that long, let’s say somebody says, I want to plan to 110, well, what that usually means is you have to spend less money, or take more risk or do something else that you might not want to do if you’re not going to actually live that long.
So we’ve been doing this for a really long time, it’s worked out pretty well, people seem pretty happy with their with their, you know, outflows that they’re able to kind of achieve from that. So again, there’s kind of this balance of, you know, if you said, Hey, I don’t think I’m going to live past 75, or something, you could spend a lot more money per year correct. Versus say, somebody else says, Hey, I want to plan to age 110. And then they would add to make that work, you’d have to spend a lot less, and so you might not have the lifestyle that you really, really want. So anyway, that’s the balance that we’re always trying to meet. But it’s a great question. It’s the number one challenge of financial planning is number one, we don’t know how long we’re going to live, right? We don’t know that. And number two, you know, if you do live for a long time, which people are starting to do more and more. So the challenge is making that money work. And that’s been it’s a good challenge is something that you can usually meet, but it’s it’s a great question.
Katie Nealis:
Are there any indicators to look out for to ensure that I won’t run out of money in retirement?
Tom Vaughan:
Yeah, it’s a it’s a good question, actually. And I would say that the best answer by far and I’ve presented this multiple times on the show, too, you want to have a financial plan in place, and you want that plan to be linked up with all of your assets, so that it’s just live. So it’s basically there every single day. And so when the market changes, you know, you can go in and take a look at it without having to go find all your statements and manually input everything. So that’s very, very possible today, what we call live financial plan, and we have those for basically all of our clients. And what we then do is we go in, and we say, okay, you know, when you’re looking at planning, you’re looking at, you know what, money’s coming in from outside. So so security be a great example, you know, maybe rents or pensions and those types of things. What assets do I have? So hopefully, that’s all LinkedIn is live? And then what am i pulling out the bottom? What am I living off of? What are my average expenses? What are some of the expenses that you know, I’m not currently having, but I might have like dental or hearing aids and those types of things, you get all that in place, and it’s solid. And this is something we do every six months with my clients. And then you do what’s called a Monte Carlo simulation. And so MonteCarlo simulation will run your plan 1000 times. And it is considered the cutting edge of kind of retirement planning. And you really want your results out of that 1000 times you want to have success. In other words, be able to make it without running out of money, at least 85% of the time, most of my clients are above 90%. If you’re below that, then we usually try to you know, continually adjust it if you’re not retired, and you’re fairly young. And you’re below that that’s not such a big issue. But once you know, as you get closer and closer, you want to get closer and closer to 85%. And then you know, as you get into retirement, you really kind of want to keep it there. And that’s how you can kind of I think that’s the best way to figure out if you’re going to run out of money, because it’ll tell you, you know, 510 15 years in advance whether you’re going to add in money, and it just gives you a chance to make adjustments as far as that goes. So it’s Yeah, it’s a really interesting area.
Easan Arulanantham:
So why is Monte Carlo so much better than like straight line because I know, people always used to use straight line just to do to figure out retirements
Yeah, I go date myself here a little bit, you know, prior to really, you know, laptops and handheld computers and the internet and what have you, you know, a financial plan for me was conducted on a yellow legal pad with a Hb 12 c calculator. And, you know, that was all straight line basis. And then we got spreadsheets, you know, I had one of the first little portable computers that I used to use with the spreadsheets. But that was all straight line also. So what you’re doing is you’re assuming, you know, certain rate of return for your investments, usually on a consistent basis, and then a certain, you know, inflation rate, for example, and all those things. And obviously, one of the real problems with that is that, for example, the market, I think you were telling me the other day, he said that the s&p 500 has only hit its average in the last 50 years, just a few years. And so if you’re using the average rate of return as your straight line calculation, it’s not a terrible thing. It’s it’s something to look at. But it is not going to be nearly as accurate as a Monte Carlo simulation, which can make some random assumptions about markets being great, one year terrible, the next to that kind of stuff. And so that that would replicate, have a better chance of replicating actual life. And that’s why MonteCarlo simulation is so much more used now than the straight line calculation, we still can see the straight line calculations, I still look at them once in a while. They’re interesting, but they’re not all that relevant in to compare to the real world.
Easan Arulanantham:
Yeah, and another thing that’s really nice is with with the simulation is we can also test like big events that have happened in the past, like, say, inflation jumps to 5%, or you have another great recession. And we can test what happens to your portfolio and your plan. If you have that event starting tomorrow, essentially.
Tom Vaughan:
Yeah, that’s my favorite piece. So I’ll I’ll do a baseline, you know, MonteCarlo simulation, hope it’s over 85%, you know, that kind of thing. And then we’ll go stress test it. So we’ll then run a Monte Carlo simulation where the computer knows we’re about to have the Great Recession, you know, a big 60% drop and what have you, what happens? What’s your percentage of probability of success out of those 1000 times when you’re standing in front of a known downturn? And so you know, what happens to your overall situation. And then the next situation is, like he said, inflation, so it’s not been very high. But now all of a sudden, it’s higher again, so maybe it stays, maybe it doesn’t, but let’s just say it does. What would happen if you had 5% inflation for the rest of your life? How does the MonteCarlo simulation work for that, I like those two a lot, because they basically show you how much stock you need to have in your portfolio, if you’re doing really poorly in the Great Recession. One is because you might have too much stock, if you’re doing really poorly in the inflation one It might be because you don’t have enough stock, because that’s one of the things that helps keep up with inflation. And so that, that, you know, the combination of those two kind of helps me craft, you know, your overall recommended exposure to the stock market, which is one of the key pieces, you know, that we deal with. So, yeah, that’s, that’s a, that’s a great piece of that. Actually, I love that.
Katie Nealis:
Well, anytime we talk about the Monte Carlo simulator, I am just absolutely floored by how powerful this is, that is just so cool that you get to use that and put in all those variable.
Tom Vaughan:
Yeah, it’s, we’ve been doing it for a while it’s not brand brand new, but it’s definitely, it’s still works. I feel very confident, you know, when I’m sitting with a client that you know, will know what’s happening, if they’re going to run out of money, you know, we can tell pretty pretty quickly, and we can make adjustments. And so I think honestly, and I’ll you know, blow my own horn here. But I think sitting down with an advisor every six months is another way to make sure that you’re doing a financial plan and having that advisor interpret that financial plan is another really good way to make sure you don’t run out of money. I mean, honestly, you know, you can do a lot of this stuff yourself, but you probably won’t have the opportunity. Like I have to do 6000 of those plans and look at them day I look at every day, day after day after day. So, you know, being able to interpret and see you know, what actually happened? So, you know, we were doing those during the 2008 downturn or you know, actual live. So we know we can replicate it now, but I was there doing that doing, you know, this, it really helps. You know, if that’s one of your main concerns you want it should be because running out of money when you’re 80 or 90 years old is just brutal. You know, what are you going to do at that point in time, so, you know, making sure that doesn’t happen should be part of your success path that you’re working on. For your retirement planning, no matter what age you are