Looking for something good to take away from the forced economic shutdown from Coronavirus-19?
Although the shutdown crimped our lifestyle, it has had the benefit of forcing us to discover our minimal required spending. No travel, no eating out, no shopping, and no activities with friends leaves only necessities to spend money on.
Knowing how much you pay each month for necessities, or your minimal required lifestyle, is a required step to creating a safety-first retirement.
In a safety-first retirement, you cover your necessary expenses with guaranteed income. You don’t rely on the stock market for even $1 of your essentials. The benefit is stress-free living.
Safety-first retirement income sources include Social Security, pensions, annuities, bonds, and cash reserves.
Imagine how stress-free you would have been this year if you had guaranteed income arriving in your checking account every month before, during and after the coronavirus lockdown.
Calculating Your Definition
In normal times it’s very hard to calculate what your essential spending would be because it’s hard to say whether things are needs or wants. Coronavirus however has limited us and created the perfect scenario for us to learn what our needs really are.
We all have different definitions of needs / minimal lifestyle / essential spending. That’s fine, but now you can easily calculate what yours is.
If you look at your average spending in March through June, subtract out any large expenses you had like home improvements, and that average spending is your essential spending. That’s as simple as it will ever be.
Once you know that number, we can investigate safe methods to generate that level of income.
More about Safety-first
This idea of a safety-first retirement is catching on in the financial planning community.
According to safety-first, the objective for retirement is first to build a safe and secure income floor for the entire retirement planning horizon… Once there is enough flooring in place, retirees can focus on upside potential with remaining assets.
Since this extra spending (such as for nice restaurants, extra vacations, etc.) is discretionary, it will not be the end of the world if it must be reduced at some point. The protected income floor is still in place to meet basic needs no matter what happens in the financial markets.
Stated again, the objective of investing in retirement is not to maximize risk adjusted returns, but first to ensure that basics will be covered in any market environment and then to invest for additional upside. [These italicized quotes come from the book titled Safety-First Retirement Planning: An Integrated Approach for a Worry-free Retirement by Wade Pfau.]
With your essential expenses covered, you know you can live a basic lifestyle (like during coronavirus), no matter what happens. If the stock market continues to do well, then you will have money to spend on fun and luxuries.
Why safety-first is a new idea
Financial advisors have generally been recommending clients hold stocks and bonds in retirement and withdraw 4% or less every year. The reason this has been the standard is that most advisors get paid based on the size of their client’s investment accounts. They charge AUM fees.
Safety-first is catching on with advisors like myself who do not rely on investment AUM fees. Andrew Marshall Financial, LLC does not suffer the conflict of interest of losing AUM when recommending you use a lump-sum of your investments to buy an immediate annuity were it the best solution for you. Furthermore, we receive no commission or kickback if you purchase an annuity.
Issues with using safety-first
The difficulty with using this strategy is getting over the fact that it usually requires handing over a large portion of your retirement savings to an insurance company to purchase an immediate annuity. (Pensioners are usually able to achieve a safety-first retirement without purchasing an annuity, but not always.)
A lot of people like the feeling of control from having their investments in an account that they can see and adjust. However, it is important to remember that when you purchase an annuity, you haven’t given up your lump-sum with nothing in return. You have guaranteed yourself food, clothing, and shelter for the remainder of you and your spouse’s lives.
Why it Works
When you purchase an annuity, you are pooling your money with all the other individuals who have purchased that annuity. The insurance company becomes responsible for your retirement investments rather than you.
By pooling your assets with other people, it becomes easier to fund everyone’s goals. If you fund your own retirement, you need to be cautious because you or your spouse may live well into your 100s. Take out too much and you could go bankrupt before then.
When you are part of a pool, the payout can be higher than the recommended 4% for self-funding because not everyone will live into their 100s. In fact, some people will die young. Their investment remains in the pool and is then spread among the remaining annuitants. Currently, a single woman in California aged 65 can receive a 5.3% payout on her purchase amount.
By pooling your resources, you accomplish the actual goal of your many years of investing; providing income that lasts your entire lifetime.
If a safety-first retirement plan sounds intriguing to you, or you worry about how you will cover your retirement spending needs, then please contact us to set up a call.