Open Pandora's box of retirement planning and everyone should know their needs.
Retirement planning is like you opened the Pandora's box and found 'Hope' coming with the Zeus's curses: the behavioral, longevity and market risks. You also face the choices on whether to accumulate or to decumulate, retirement income or return on investment, and to survive or to thrive. Look for the features from the financial products you plan retirement: predictable or even guarantee, live as long as you do, auto pilot to your goal, and cash flow rather than assets. Last and foremost: Live long and live happy with planning for retirement in advance.
Ever since the pension plans shifting from defined benefit (DB) to defined contribution (DC) plans, it's like the employees opening the Pandora's box that everyone start to concern about their retirement plans. Many risks previously being taken by the employers are now transferred to the employees. The employees have to prepare more about their retirement life because they previously relied on social securities and corporate pension plans to cover the majority of retirement financial needs but it's no longer the case anymore.
What's inside the Pandora's box?
The Pandora's box was opened, what are the Zeus's curse?inside? With DC pension plan you're the pilot of your retirement portfolio. Good or bad is that you're in control of your investment portfolio. The psychology of the greed to speculate or the fear not to take any risk can cause bad decisions even when you're young and mentally competent. The?behavioral risk?will be even worse if you become older and mentally incompetent to make the right choice. You can no longer take care of investment to buy and sell stocks to obtain the money you need.
Living long has been the best wishes from ancient time so how can it become a curse? Longevity is a curse if you live long with poverty or a blessing if you have prepared sufficient money to 'Live long and prosper.' Of course you don't need to be Mr. Spock to control the?longevity risk. Long life is a rising trend affecting most people and basically people can live another couple years longer with every ten years passed.
After the financial crisis, we've seen black swan effect to crash the stock market overwhelmingly. Now people talk about grey rhino effect that we may overlook the obvious danger and didn't take action to avoid the?market risk. The ups and downs of market cycle can last anywhere from a few weeks to several years, depending on the market in question and the time horizon at which you are looking. When you're retired, you wish the bullish market can come back soon but you may not live long enough to see the upside and lose all your nest eggs for retirement living, no one can be spared.
The behavioral, longevity and market risks are Zeus's curse?coming with the Pandora's box of retirement planning. You want to manage these risks while you still can make the right choices.
Your choice 1: to accumulate (the assets / savings) or to decumulate (the cash flow / income)?
When people talked about retirement planning in the past, they usually mentioned ‘How to save $1 million for retirement’, which means?to accumulate the assets. That worked well when the market perspective is positive and interest rate is high that people can easily gain a reasonable cash flow from their sizable saving any time they want.
The above retirement financial plan chart shows that you’d better start your retirement financial planning if you are at the age of 45 and plan to retire at the age of 65. In this case you only have 20 years to prepare for next 30 years which you’re very like to live because of longevity. The slope of the left-hand-side accumulation period (the saving) is much steeper than the right-hand-side decumulation period (the expense).
Because of the longevity risk, people can’t estimate their life length and this fact makes accumulation a tough job that no one knows ‘How much is enough?’ Here we are not talking about controlling your desire to live at the minimum standard but that the length of life is unpredictable to prepare. Accumulated assets can be insufficient if you live longer than expected.
People tend to think they won’t need too much money after retirement. People still have a minimum requirement of living expense including healthcare expense no matter how low you control the desire.?Indeed the retirement financial needs for living is the continuous retirement income rather than the sizable retirement assets. Many elderly living in a big mansion without stable income source still need money for living and this is where the reverse mortgage comes in.
In short, if you have difficulty to obtain a cash flow from the assets, you still can’t live without?decumulating the cash flow.?Accumulating the assets is necessary before retirement to build up the savings but you need to ensure the assets can generate a stable and continuous cash flow along with your retirement.
Your choice 2: ROI (return on investment) or RI (retirement income)?
Many people didn’t use investment as a vehicle for retirement because of the fears to take any risk so they simply use the most conservative vehicle, like certificate of deposit (CD), to prepare for the nest egg. There is nothing wrong not to take market risk to make investment only this approach isn’t effective that interest rate is so low to accumulate money in as short as 20 years. Relying on the interests from CD to retire, people will need to put in a lot of money with current 1% interest rate. Taking some risks in pre-retirement stage is needed if people want to accumulate the retirement funds faster.
The other side of the psychology is the greed to speculate or buying high and selling low. Many people tend to compare investment performance, like?return on investment (ROI), to choose the financial products. Higher return usually goes with higher risk so pursuing ROI and switching between products in younger age before 55 is fine. As it approaches to the planned retirement age like 10 years before, people need to think about which product can generate the?retirement income?when you need it.
Instead of going after the ups and downs in the market and dancing with ROIs, you want to live a worry-free retirement with a stable retirement income.
领英推荐
Your choice 3: quality life or to thrifty life?
What kind of retirement life you’re look for? To?live the simplest thrifty life till you die or to?live?a quality life. It’s an easy choice to make that everyone is looking for the latter. But how? You should identify the needs, wants and desires component of your retirement life.
Retirement financial planning is like building a house. The foundation is?your needs. It depends on everyone’s expectation that the needs standard may vary from person to person. It’s the minimum living standard, plus basic social activities and healthcare expenses. You don’t want to just survive and never go out of the house that you may not have extra money for it. You use a predictable cash flow to fund your needs.
On top of the foundation, the pillars and walls are?your wants. To thrive a happy retirement, you want to do something for yourself. Leaning a musical instrument or contributing yourself to volunteer works fall into this category. This portion is not necessary to live so you can take some risk if you don’t have enough money for it.
The decorations definitely are?your desires. Something you always want to try but never have an opportunity or money to do it. Travelling around the world or acting like a millionaire for one day fall into this category. This portion can be your dream coming true or a luxury to have. If you have extra money, you can put it to fund this.
To survive or to thrive, that is the question. Without separate nest eggs for each category of your needs, wants and desires, you won't have too much choices. Clarify the amount of money for each category and prepare them with different investment vehicles. The higher portion of the Retirement Income Pyramid, the higher risk you can bear to live without them.
How to choose a financial product for retirement?
The retirement financial plan should control the risks so you don’t have to worry about it. So how to choose the financial product?
Predictable or even guarantee.
To control market risk, a portion of income should be predictable or even guarantee so as to maintain the minimum living standard, basic social activities and extra healthcare expense.
Live as long as you do.
To control the longevity risk, the financial product should live as long as you do or you will exhaust the income and face the poverty too soon. Surely CD plays a perfect role to live as long as you do.
Auto pilot to your goal.
To avoid the behavioral risk, the financial product should target you financial goals so that you don’t have to switch gears after retirement. Auto pilot financial product can target your goals even when you have dementia or any mentally incompetent condition.
Cash flow rather than assets.
You need the living expense for every month, period. No matter how much asset you own, whether it’s a big mansion or a Porsche 911, as long as it can’t provide income stream for you every month, you’re in trouble.
No matter the financial product you use to prepare for retirement are re real estate, equity, fixed income, insurance, or mutual fund. It should have the above features to give a worry-free retirement. Last and foremost, live long and live happy with planning for retirement in advance. The Pandora’s box isn't that scary if you get prepared.