Planning for retirement has many unknowns, so there can be no certainty. For most of us, the prudent path is to:
- Save as much as reasonably possible
- Estimate your expenses when you’re considering retirement
- Estimate your income, including both fixed income (i.e. Social Security) and investment income (including both dividends and proceeds from sales)
- Determine if your income will meet your expenses and make changes accordingly
The biggest unknown is the future performance of your investments. In order to get a better understanding of this most advisors run some kind of simulation. Most of these simulations do a poor job of explaining the underlying assumptions (i.e. will the market continue to go up?) and what the bumps may look like along the way. Therefore, I have developed a simulation ( Click here for a sample) that is designed to clearly communicate what your financial future may look like. Note that:
- It is a 20 year simulation. Forecasting further into the future is pointless. Instead, you should revisit your forecast every few years.
- The “Annual Asset Balance” graph shows 10 different possibilities. Your actual outcome will not match any of these, but it gives you an idea of the variation in the forecasts.
- The “Annual Cash Flow Simulation” shows what your net worth might look like over 20 years. It is almost certain that at least one of these years will be awful. If you can’t tolerate a significant drop in your net worth, then you need to change your asset allocation (more bonds and/or annuity) until the outcome is acceptable. The worst thing you can do is wait for the markets to drop and then move out of stocks.
A good future forecast is essential to do before you retire. It will determine if you’re able to retire and your investments and budget when you do retire.