Retirement is a unique stage of our lives that at this writing can last a third or more of the years we strut about on this earth. It has its own financial dynamics, different from earlier stages primarily focused on accumulating wealth. Retirement planning is primarily about spending down the wealth we’ve accumulated. That’s why how we manage our retirement wealth, referred to colloquially as our “nest egg,” differs diametrically from investment approaches we may have applied earlier when achieving our other financial goals.
In a nutshell, retirement planning is about generating replacement cash flow. When you stop earning income, those missing paychecks need to be replaced by regular payments from other sources if you want to continue to sustain the lifestyle to which you aspire and/or have grown accustomed.
Thus, in retirement, cash flow is king, but it’s not just any cash flow. To win at the game, retirement cash flow has to meet seven challenging requirements:
1. It must last a lifetime—or two lifetimes if you have a spouse or significant other you care about. But longevity increases with each passing year, so the duration of your retirement income must be open-ended. You simply don’t know how many years you may have.
2. Running out can mean literal ruin, so If you can get it, you want that life-long income to be guaranteed. Say what? What does a “guarantee” even mean in today’s financial world?
3. Retirement income must be impervious to market volatility and losses. The vagaries of global financial markets—including bond markets— must not be allowed to reduce it, because once reduced it’s hard to recover prior levels.
4. Somehow, your retirement income needs to increase to keep up with inflation averaging at least 2% to 4% a year. Without compensating for that erosive force, your purchasing power will lose ground, i.e. you will grow poorer. A fixed income—the same amount paid year in and year out like a pension—simply won’t cut it.
5. Your core income should be at least enough to sustain your desired consumption, i.e., your lifestyle. In our economy, you don’t want to stop consuming. While you can, you need to keep doing so for your own sense of pride; the economy needs you to consume because consumption is its life spring.
6. Ideally, your growing income floor should be reliably under your personal control, pouring out of your properly invested nest egg. This makes you self-reliant. Facing an age of acute uncertainty, you want to be self-reliant.
7. Your core income floor can then be supplemented with cash flow from other sources, like Social Security and a Pension, to create a surplus. If you can see to it, your guaranteed lifetime income should be more than you (think you) need so you can feel free to be generous to yourself and others—without living in constant dread of depletion.
Sounds like a tall order, doesn’t it? That’s because generating “free cash flow” in retirement in the form of guaranteed surpluses is just that. If you think you can do it yourself, good luck. If you’re working with an advisor, make sure he or she knows the real objective and can show you how to achieve it. The good news is that thanks to some of today’s most ingenious financial innovations, it can be done.