Is there a "Number" for you?

Back in 2010, the ING financial services firm ran a marketing campaign asking what is “Your Number?”  The purpose was to encourage people to identify and calculate the total amount of money they need to have saved by the time they retire.  This campaign, though memorable, was criticized roundly as being too trivial and naïve and it oversimplified retirement planning to be of any real use.  But, was that too harsh a criticism?  What can we learn from “your number”?

Today’s investment modeling software has taken a good stab at answering this question.  MoneyGuidePro, one of the leading “fintech” planning softwares, does a good job at statistically calculating the “probability of success” of a retirement plan when all the relevant factors such as projected income, expenses, and investment portfolio are modeled.  Your “Number” is only part of the answer, but an important part.  Let’s see how it works.

Assume that you are 66 years old and your wife is 62 and you want to retire today.  Both you and your wife are eligible for social security at the maximum benefit at full retirement age and age 62 of $3,011 and $2,265 per month, respectively; $63,312 per year combined (pre-tax) with an annual inflation adjustment.  Let also assume that there is no pension, annuity, or other source of income.  Based on actuarial models, assuming good health, we can plan out 33 years; age 92 for the husband and age 94 for the wife.

With the income side taken care of, what about expenses?  Most people have a standard of living that they have become accustomed to and want to maintain it into retirement, including inflation.  How much that costs is specific to each family, but we can take some short cuts to model it out.  For example, for our sample family, let’s assume that they spend a level $6,000 per month (after-tax) to support their lifestyle (though we know spending is not “level”) and it inflates by 2.25% per year.

Now, let’s get to the investment portfolio; the part of the equation we are trying to solve for.  Once all the factors are populated into the model we can work backwards to determine statistically how large your investment portfolio should be to provide a safe “probability of success”, i.e., the level where you have enough income and assets to cover your expense through the “end of plan”.   For this example, we will assume a 50% equity weighting with 70% of the investments in tax-deferred vehicles (IRAs, 401-ks, etc.) and 30% in taxable accounts.

So, run the model and the answer pops out:  for this fictional family, their “number” is $490,000.  This means that there is an 80% probability of success (see chart below) that this family’s social security income of $63,312 per year (pre-tax), expenses of $72,000 per year (after-tax) and investment portfolio of $490,000 is enough to last the next 33 years without a deficit.  Higher living expenses would require more investments, and vice versa.

80pctSuccess.jpg

Sounds good, right?  Wrong!  There are many things that could go wrong.  The list is quite long and includes things like higher inflation, medical expenses and unplanned expenses, long term care costs, increased taxes, early or late death, value of a home, desired bequeaths, etc.  Also, there are many things that can impact the investment portfolio and the ultimate probability of success including the underlying risk profile, volatility and sequence of returns, investment expenses, and the asset class allocations.

Calculation of “Your Number” makes most sense when you are close to retirement and want some assurance that you have the financial wherewithal to proceed with a degree of success; especially since there are no “do-overs” in this league!  Since the inputs into the model are likely to change over time, it is important to update the plan on a somewhat regular basis, or when there is a material change in something.  For more on this topic, check out my prior post on our blog, here:  https://www.dattilioash.com/our-blog/2019/7/29/do-you-need-a-retirement-plan