My retirement plan in 5 minutes | Kiplinger

The most common mistake people make when planning for retirement is to assume that the way the wealth was created is the same as they should hold the wealth in retirement, with the added benefit of being more conservative.

Popular belief suggests that as you get older, the level of risk an investor takes should decrease in order to preserve their assets and protect them from market losses. The general idea here is that the younger you are, the more aggressive you have to be. The older you are, the more careful you should be.

The theory is that too much risk can lead to losses if markets fall with less time to recover, and by reducing risk this can help minimize losses.

But here’s the problem: when you reduce risk, you can solve the problem of volatility and overall exposure to market losses, but at the same time, you reduce your potential for gains – which of course is oxygen. a pension plan.

It’s a double-edged sword: if you take too much risk, you run the risk of losing money. If you don’t take enough risks, you run the risk of running out of money. Most people find it difficult to find a balance, especially in a low interest rate environment like the one we find ourselves in today.

Investment problems for income

One approach often used is simply to keep the risk moderately high with the belief that profits can be skimmed off the portfolio in a way that aims to protect capital while allowing the portfolio to grow over the long term. A variation of this would be to use a dividend portfolio, where you can receive dividends for income.

With either of these strategies, you are faced with uncertainty as to how much income you will receive from quarter to quarter and are forced to accept the possibility of not having a profit over the course of the year. in a given year due to market volatility or low company earnings.

The way this plays out in real life is that income should be taken regardless of the performance of the market because there is a need for income in retirement. The result is that the problem is exacerbated, because in the absence of income, you deplete the capital, which only makes the problem worse.

And if you think bonds are the answer, think again. With rising interest rates, there is a high probability of losing principal or having bond yields below inflation rates. Finding a fixed income alternative is a serious challenge.

What about the 4% rule?

Another popular idea is what is known as the “4% rule” for making distributions. The theory is that, based on past performance, if you withdraw 4% from your accounts, you statistically “should” hold those assets for 30 years.

This raises another issue beyond the potential for market losses, namely the effects of inflation. Inflation is the silent killer of all retirement plans, gradually reducing the purchasing power of your assets over time.

To shed some light on this problem, consider the annualized return your portfolio must have to meet the need for a 4% distribution, a 3% inflation rate, and approximately 1% fees. The calculations conclude that the breakeven point is 8% year over year regardless of years of decline or volatility.

The risk here is longevity, which is why the 4% rule suggests a period of 30 years. It is assumed that you will eventually run out of money. Add to that a few bad years in the market and you have a recipe for an acceleration of master exhaustion.

For a growth portfolio to flourish, the account needs time to do what its name suggests: grow. And when you earn income from a portfolio designed for growth, you’re sabotaging progress.

Here’s what happens with all of these scenarios. There is an assumption that the way wealth was created – usually using a portfolio of growth stocks and ETFs – is the same way wealth should be held in retirement, but with a more conservative approach.

All the confusion and challenges of generating income… they all stem from this misconception. The mindset that rate of return and growth is the means of distributing income is the problem and cannot be achieved without a lot of luck on your side, and it is not a retirement plan.

The retirement plan in 5 minutes explained

Most clients come to me for help when they’re stuck and going from having to work for a living to worrying about their money to make a living, and that’s not a picture either. of freedom. The solution to this is really quite simple when you realize that the growth of money is done one way and the distribution of income is done in another.

The caveat is this, financial freedom is only achieved if income is sustainable and you don’t wake up every day wondering if that freedom is going to be swept away with the next pandemic, some political decision, some decisions. leadership and a multitude of other things beyond your control

So, once you’ve focused your thinking on income, to run the five-minute retirement plan, you start by figuring out how much income you need to supplement your Social Security and retirement income to live the life you want. wish. You have to know this or else you are just making up numbers, and that only makes the problem worse.

Once you figure that out, you take that total annual income and divide it by 6%. (Why 6%? That’s the average using my Assets2Income ™ method. And if you want to know more about it, Click here.)

The result of this calculation provides you with the approximate amount to set aside and devote to generate the income you need right now to retire while the remaining assets are segregated and invested for the long term as an inflation hedge.

The advantage of this method is the ability to focus on the purpose of each pool of money. Here is an example of how it works:

Under the 4% rule using a typical “conservative” allowance, a $ 1 million retirement account would generate $ 40,000 in income without accounting for inflation, as previously described.

Using the Assets2Income ™ method, the same income of $ 40,000 could be generated using $ 667,000 out of the million dollars, leaving the remaining $ 333,000 available for long-term investing as an inflation hedge.

The main point to remember here is that the assets should be segregated and allocated based on what purpose you have for the money. It’s part of the five-minute retirement plan, and coupled with the Assets2Income ™ method, retirees are able to strategically segregate their assets and resolve the two biggest variables in their retirement: income now and income plus. late. You can read more about Assets2Income here: https://brianskrobonja.com/training-video

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