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Written by: Jim Phillips
The shift that occurs when someone moves from saving money to relying on those savings to fund their daily spending can be dramatic.
When an untimely life event accelerates their retirement date, retirees may find themselves without a regular income stream and suddenly need to lean more heavily on their investments than anticipated.
How did they go from someone “with a plan” to being a newly inducted member of “the close-call club” (as Christine Benz once referred to it)? And, as an advisor, how can you help them shift gears and put in place a reasonable decumulation plan that is both practical and feasible?
What matters most is the retiree’s ability to believe in the plan and take action on it. The math has to work and, at a certain point, the math becomes an article of faith.
While the specific circumstances may differ, the response may be familiar: When retirees start taking out withdrawals to pay for living expenses, their views on money and spending may change.
Understandably anxious for the future and doubting the resilience of their nest egg, it may be hard for them to tap the money they worked so hard to save over their lifetimes. Their previous spending habits may give way to frugality. Admittedly, in some cases, this might be a good thing.
While frugality for frugality's sake is not optimal, it may not be so closely related to saving money as one might think. It might be a practical application of a more minimalist approach to living or a predictable response to the constant barrage of marketing messages targeted at consumers to (always) acquire more.
Add to that a vertiginous moment of life transition, and frugality can serve as a defense mechanism: A way to regain some control in the face of a paradigmatic shift in identity when the rules of the game have suddenly changed.
In an effort to help retirees come to terms with the new reality of their situation and potentially allay their concerns, one tool in the advisor‘s toolbox is to run a Monte Carlo simulation.
It may surprise people that even when the plan is completely updated to reflect the retiree’s new situation and even when the Monte Carlo results come in strong, it may still not do the trick for some stalwart retirees who remain (overly) cautious. The plan indicates an ability to spend more, earlier, but they may remain entrenched in a mode of frugality.
When presented with a Monte Carlo projection, a retiree may attempt to adjust their spending estimates downward in the platform, or decrease the rate of inflation, or increase their rate of return. In short, they may attempt to tweak the parameters to achieve a score that aligns with their conception of how they wish the future to be.
It is one of those situations when more information doesn’t equal a more complete understanding of what will happen in the (unknowable) future.
The result? Dissonance is generated between the planning process and the retiree’s interpretation of the plan. The lingering sting of the sudden life transition is what matters most for the retiree at this moment.
At some deep level, advisors understand the core issue: Can probabilistic models really capture all the uncertainty of life and the “slings and arrows of outrageous fortune”? Even a minute possibility of negative outcomes (think Sequence of Returns risk) can give rise to hesitancy as the retirees review these otherwise valid and statistically sound calculations.
Reflecting on this hesitancy surrounding the Monte Carlo simulation, I began to consider ways to help people understand what is actually happening in Sequence of Returns risk.
Sequence of Returns risk looms so large as a concern because it is hard to make the connection between how it is actually playing out and its consequent impacts on our future. How we perceive the risk is the issue. And, this not-knowing triggers us, at some primal level, to infer a potential future loss.
So, I developed a formula to look more closely at how the amount withdrawn (to sustain a planned level of spending) compares with how the overall portfolio was actually affected by inflation and market performance.
This simple measure, which I have dubbed the “decumulation ratio,” seeks to describe the impact of Sequence of Returns risk in context to the retiree’s lived experience.
If people could begin to look more closely at the actual implications of Sequence of Returns risk, track it at a more granular level, and then consider it longitudinally, it may help retirees adapt their perception of risk and overcome what can be a pernicious mindset.
I have written an article on LinkedIn that delves more deeply into Sequence of Returns risk and the decumulation ratio. If you would like to provide me with feedback, please check it out and leave me a comment.
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