The Math of Retirement

There are many ways to look at your financial circumstances over the course of a lifetime, but at some point we all give some thought about how well prepared we are for retirement. Will money be tight, or will we have plenty to live the life we envision? Do we need to make changes in investments, spending or expectations? Let’s explore three financial elements that affect the math of retirement.

Should I keep working?

This is a question we often discuss with our clients, so here is some food for thought. The answer is primarily based on two factors: future expenses and current and future resources. Your future resources include your personal human capital — the salary, bonus, stock options and other income related to your work. Your human capital can be summed up into a present value that helps to clarify whether you need to continue to work or not.

For example: What’s the value of working five more years? An extra $500K per year in income for five years plus a $1M bonus in the fifth year is worth about $2M in today’s after-tax dollars. If this number doesn’t make a big impact in your overall net worth picture, then it may be worth seriously considering taking a step into less stressful and less time-consuming work. In other words, working primarily for enjoyment rather than income. The late Kobe Bryant often said, “You have to love what you do.”

How will I fund my spending?

All expenses are not created equal, especially in retirement. We break expenses into three categories:

• Essential expenses: These baseline expenses are those you wouldn’t compromise on. Like mortgages, cell phone bills, groceries, medical expenses, etc.
• Important expenses: Future family education or wedding costs. Important but can be managed down if necessary.
• Discretionary expenses: A second home, extra cars, travel, charitable gifts. These are items you can live without.

Your retirement math will be influenced by your mix of essential, important and discretionary spending. Keep in mind that these categories can change over time. Housing costs could go down as medical costs go up. Travel may show up more in some years than in others. Your kids can borrow for education, but you can’t borrow for your retirement.

We find it helpful to match up or balance different expense categories with different segments of your asset allocation. Cash and fixed income can be balanced against essential expenses. Equity and private growth investments can be balanced against important, discretionary and even future wealth transfers. The balancing act has less to do with risk and more to do with uncertainty. It’s possible to take the uncertainty out of investing by ensuring you have enough to cover your essentials in perpetuity. The rest can be invested for the upside, knowing that you can manage these expenses if circumstances change.

Does Social Security matter?

After paying into Social Security for a lifetime, this future cash stream is a neglected hole in most balance sheets. It shouldn’t be.

A high earner who has worked and paid taxes for decades can expect a significant income stream via Social Security. The present value of these payments typically adds up to between $1M to $1.5M. It’s real money. You can view your estimated Social Security income by visiting the agency’s website. You may be surprised.

Despite its considerable value, most people don’t count on Social Security as a reality. Even though it functions perfectly fine today, many believe extended lifespans will disrupt the balance between contributions and distributions, forcing politicians to eventually eliminate Social Security payments altogether. There are merits to that argument, but for the time being, Social Security is in fact paid in full on a regular basis to its current beneficiaries. If you are anywhere near to 65, you can reasonably count on that income. It should be included in the math applied to your financial future.

The importance of allocation

Whether you consider the questions above at age 45 or 75, the need to compare resources and expenses remains the same. We’ve helped many clients compute and understand these calculations as a way to understand the impact of their investments. Among other things, the math illuminates what your portfolio has to provide to support your lifestyle and eventual legacy. For some, it means reducing risk exposure, as protection is just as important as growth and returns. All of these factors are important to consider in your family’s investment decisions.