How Situational Investing works
It starts with determining your expenses:
A common rule of thumb that you will see online and in advertisements says you will likely need about 80 percent of your pre-retirement income during retirement. This figure assumes that, while your overall spending habits may remain the same, you won’t be putting money in a retirement plan and you will drop any work-related expenses.
This estimate can be a decent starting point, but it does not take into account your specific plans. We start with a more in-depth look at your financial picture. With the help of a CFP®, we can help you feel confident that you know how much you will be spending in retirement.
Then you define your income:
You have options on how to take your Social Security benefits that need to be reviewed. Should you start taking Social Security at age 62, or should you wait and let your benefit grow? In addition, you need to define any income you expect to have from pensions and any other source like rental income or anticipated part-time work.
Quantify your Income Gap:
Once you know how much you expect to spend and how much you anticipate as income in retirement, you know how much you will need to take from your investments to meet your expenses. Most people have more expenses than income in retirement – it is why we save for retirement. We call the amount you will have to take from your savings your “income gap.”
What is your Required Rate of Return?
Your Required Rate of Return is the amount of earnings you need your invested savings to return in order to meet your income gap and leave your principal intact. To determine your Required Rate of Return, divide your income gap by the total amount of savings you have.
It is common for people to want to spend principal in retirement, after all, you saved it, why shouldn’t you be able to spend it? We have two reasons. First, you want to make sure the money lasts, and once you start to spend principal, the remaining funds have to earn more the next year to try and meet the same income gap. When you start spending principal, you increase the odds of running out of money exponentially. Secondly, protecting the principal can provide you a source of funds that can be available if long-term care or other large needs arise.
Situational Investing, What’s Really Important?
Conventional wisdom states that your investment strategy should become more conservative as you age — the thought being that younger investors can afford to take more risks because they’ve got more time to recover any losses. However, risk needs to be balanced against need. Your income gap defines your need, and your goal is to earn enough to cover this need. If your Required Rate of Return is high and requires taking too much investment risk to try and meet it, then you may have to reevaluate your retirement goals. Options include delaying retirement, phasing into retirement with a part-time job or consulting, and reducing your lifestyle and spending less in retirement.
The Situational Investment Planning process is ongoing. No plan can reasonably predict what is going to happen over the next 10, 20, or 30 years. As market conditions change and your spending patterns change, your plan needs to be adjusted to match.
In the end, that’s what Situational Investment Planning is all about: taking the time to understand your personal and financial goals so we can design a plan that gets you where you want to go.
Ready to get started? Contact us to schedule a meeting with our team.