Retirement Planning: Morticians Vs. Obstetricians
By Henry K. (Bud) Hebeler
John Andrew was a co-worker with me at Boeing who often helped me develop our company's long range plan. John said that planners either were morticians or obstetricians. The morticians always looked at what could go wrong and often killed projects with their dire predictions. On the other hand, the obstetricians were always creative optimists that gave birth to new ideas and products.
Almost all retirement planners are obstetricians. They try to create ways to make your future look brighter. They usually ignore the need for emergency reserves, look optimistically at the future returns from investments, and sweep the costs of buying, owning, and selling investments under the table.
On the other hand, I admit to being a mortician as far as planning projections are concerned. Part of this comes from six years of forecasting Boeing's long range future where I had to substantially tone down the inputs from all of the obstetricians. The rest of my observations come from working with people with inadequate retirement resources and reviewing the actual year-by-year performance that would have been achieved historically using the methods of the obstetricians.
After more than a decade of looking at retirement planning methods and their associated projections, I have come to the following conclusions:
(1) Never assume that you can predict all of your future expenses. Always keep some kind of a reserve that is only for emergencies and the unforeseen. When in retirement consider a reserve about equal to two year's of expenses that are not covered by Social Security and a pension. In bad times, you can use some of the reserve. In good times you can replenish it.
(2) Never base your projection of the future on optimistic periods in past history where returns were high and inflation was low. Some planners even choose one period for high returns and another period with low inflation. Be wary of those who say the government can now protect us from market declines and high inflation. Choose returns that match your particular investment allocations and consider that, as you get older, your allocations will get more conservative so your returns will get lower as you get older.
(3) Never ignore the costs of buying, owning, and selling investments. As a practical matter, on an historic basis, the underlying securities of a retirement portfolio comprised of about equal parts of stocks and fixed income securities might have a real (inflation adjusted) return of about 4%. If these underlying securities are in no-load mutual funds with typical annual costs of 1.5%, the net real return is only 2.5%. This means that more than one-third of your real earnings is going for fund costs. If these funds are managed by a professional charging 1% of the asset value each year, the net real return is down to 1.5%. If these are high-turnover funds in taxable accounts, the real return may be negative. It's not hard to lose all of your real growth to a combination of financial managers and the government.
(4) Even after accounting for (2) and (3) above, never use your actual estimate of a return for a post-retirement projection of your spending capability. I've found that using only about one-half of this value better projects what would have happened historically than using the whole value. This is due to several factors. First, at least half of the time, the real outcome will be less than a projection based on a 50% probability. In fact, there can be an unacceptable probability that the returns will be significantly less. Reverse dollar cost averaging easily can reduce your returns by more than 1%. Second, each additional year that you live extends the year projected for your death. Therefore, your funds must be stretched over a longer period. For example using IRS 590, a 65-year-old would project dying at age 85, but after reaching 85, the projection would change to living until age 92.
To illustrate results, we'll use some examples with constant dollar values that have been adjusted for inflation to represent constant purchasing power. Suppose a couple saved $10,000 (adjusted upwards every year for inflation) each year for 20 years in a portfolio with 50% large company stocks, 40% long-term corporate bonds, and 10% in a treasury bill money market starting in the year 1940. In 1961 they retire at age 65 with a balance of $342,000 after which we'll see how much they can use for retirement each year.
The obstetrician who ignores investment costs and uses average values of returns predicts a retirement budget of about $27,000 in the first year of retirement. However, ten years into retirement the budget projection is reduced to $16,000 a year. After another 10 years, the retirement projection is less than $5,000 a year. In the last year of their life, the budget is $3,400.
On the other hand, the mortician makes an initial projection of $16,000 in the first year of retirement. Ten years into retirement, the projection is still $16,000. After another 10 years, the retirement projection is $10,000. In the last year of their life, the budget is $7,600.
Those of you who would like to preserve a larger budget late in retirement will have to start with a significant reserve. The obstetrician's reserve has to be huge, while the mortician's can be much more modest.
Now, would you rather follow the mortician or the obstetrician? The obstetrician lives gloriously for the first couple years of retirement but really takes it in the shorts for the majority of retirement. The mortician starts off more modestly with less hope of dying rich. However, the mortician almost always ends up richer!
Note: You can experiment with your own values using the Retirement Autopilot from www.analyzenow.com. Keep in mind that no one can predict the future. There is no warranty expressed or implied herein. This material is presented AS IS. Seek professional assistance for your particular situation.