Having enough to live on until the day you die – that has to be the clear and unfettered goal of every retiree. Only when that objective is secure can we move on to grander visions of a golden retirement, or passing on an estate.
As they say in Alien: “All other priorities are rescinded.”
I’m dealing with this now as a close relative of mine needs help to make safe her income. She’s up against the ravages of inflation, a Darwinian stock market, sharky financial advisors, and a risk tolerance lower than a nun in Caesar’s Palace.
She doesn’t have a defined benefit plan, or sources of income beyond the state pension, and her pensionable assets are modest.
Making a happy retirement out of that lot can be done but it will be touch and go. We will have to put the chips on the right squares and there will be no second throw of the dice.
What really matters?
Daunting choices and goals have been swirling around my relative, leaving her frozen in the fog. What’s needed is a retirement plan filter to help her see clearly.
Here’s what I’ve come up with:
- How much you got? In pensionable assets and any other income that will help your retirement. For many people, “other income” will just be the state pension.
- How much you need? What’s the minimum amount you can live on and be reasonably happy? I’m not talking breadline bleakness here but jetting to Capri on a whim is probably out, too.
- How much you want? Okay, here’s where those Capri weekenders come in. What other lifestyle goals and dreams do you have. For example traveling the world, passing on an inheritance, and so on.
Once you have the answers to these questions you can set about your strategy.
The least risky options available are outlined by William Bernstein – the renowned passive investing champion – in his excellent book, The Ages of the Investor.
Bernstein counsels a two-part retirement strategy:
1. Create a minimum income floor – This aims to meet your basic retirement needs for the rest of your days, and is generated using near risk-free assets.
2. Create a risk portfolio for the fun stuff – Legacies, Gucci bags, and bionic parts are funded by (hopefully) the rise in value of this portfolio. As the name suggests, you can afford to take more risk here because your basic needs are already secure. Though some of the risk portfolio should always be in cash to handle emergencies.
Critically, by ring-fencing the two parts of your retirement plan, you won’t endanger your survival income by taking risks in pursuit of the good stuff.
In this follow up post, I take a look at the best options for nailing down that all-important income floor.
Take it steady,
Interesting view on the two-part approach to the basics and luxuries end (corresponding the neeeds and wants of the working age saver). There is some problem where you have to take a view of the future – high inflation and low inflation are going to shift the balance there.
It’s hard to qualify those needs while working, however. Having more time does make some sorts of money saving (or getting better value for the same money) easier.
Kudo on calling this split – many articles about retirement treat the wants and needs as one lump, whereas running two investment philosophies sounds like a much better way to look at it. I have taken that approach, though I’m not splitting it out of a homogenous saved capital because I have a deferred pension for the needs part. It makes me more risk-tolerant on the other part of my retirement savings and ISA savings, which seems to be along the lines of where you’re going with this.
While retirement is a dim and distant thought that I have 20-30 years to worry about, I like the needs and wants split you have picked up on.
It reminds me of Tim Hale’s thoughts in Smarter Investing (which were linked, in turn, to Maslow’s hierarchy of needs).
As someone investing in index trackers wherever possible (and making use of the Vanguard LifeStrategy funds), part of me wonders whether I should be thinking in terms of two retirement ‘pots’, with a higher ratio of bonds for ‘floor fund’ and a ‘fun fund’ that’s 100% in equities.
Assuming holding funds in this way didn’t end up costing any more, of course 😉
What a simple yet brilliant concept!
I’d always considered splitting equally whatever I have at retirement between a guaranteed annuity and some income producing investments; to ‘minimise’ the risk of making the wrong decision.
Using an annuity to cover and guarantee the ‘minimum income floor’, and investing (most of) the rest seems an even better idea (assuming that’s where you’re going with the next article ;)).
Makes a lot of sense and similar to the flexible drawdown rules.
That’s a very sensible approach that Bernstein suggests. Whilst particularly applicable to retirement, there is no reason that can’t be extended to any point in our lives. And doing so, if all goes well with our ‘risk portfolio’ then hopefully by the time retirement comes along, we will have raised the level of that basic floor considerably.
I’ve come across similar strategies in various guises before, even some peddled by life offices such as Pru et al. Their solution was to use conventional (index linked) annuities for the ‘basic needs’ element, with investment linked (or with profits) annuities for the ‘fun’ element.
In principle, it seems like a logical approach, although I expect that as with anything there will be pros and cons. One that immediately springs to mind is that overall retirement income could be lower than if a more standard approach had been adopted (say using a safe withdrawal rate of 4% on a ‘balanced’ portfolio).
Also, heavy losses suffered in the early years on the fun pot could devastate that pot, again reducing overall income had a more conventional approach been adopted.
As ever, there are no right answers in this game of financial planning (DIY or otherwise)…
I plan to use annuities as my income floor and HYP, ETFs (bonds & shares) as my fun generators. Lets hope annuity rates improve by the time i get there.
TA, looking forward to your next article. Would like your views on specific amounts of income required. Assuming mortgage paid off and no kids to support, my view on income actually required:
£1,000 per month – minimum required to survive (council tax, bills, basic food).
£2,000 per month – Reasonable quality of life, annual overseas holiday, eat out occasionally, run a car, goto cinema etc
£3,000 per month – This is my goal. Good quality of life and should be able to save income each month which will compound further protecting against inflation.
In reality I will continue working and generate additional income but that will be my choice, whether that’s a part time delivery driver, stacking shelves at B & Q on the weekends. Also, don’t forget your partners income.
Good approach: simple and instictively right. In fact, this is pretty much what we did when calculating retirement: we thought about what we need and want we want. One thing we did differently concerns the ‘want’ part: we took this much more like ‘life-style design’ than traditional retirement and started with a vision of the life we would like to lead.
Are your ‘rule of thumb’ figures per person or per couple?
Worth pointing out that the proposed flat rate pension at £140 per week would give about £1000 a month for a couple, half that for an individual.
My father’s income is something over £2000 per month and, until he required increased care input to help him stay in his own home, was masses for a single elderly man. Now well over half of this is going on care of one sort or another (and he isn’t even particularly unwell, just frail, forgetful and liable to neglect his basic needs if left to his own devices). Care needs are a major part of retirement budget planning imo (if you have almost any sort of house paid for you will need to self fund) – even if the ‘plan’ is to use your property equity. Personally I’d want to have enough flexibility to pay for the care I felt I needed for my own comfort.
Of course, the real challenge for people retiring into todays enviroment is how to keep up with inflation over the next 20-30 years, given the very poor (negative real) returns on low risk investments, and the likely poor outlook even for risk assets (inflation linked annuity perchance?)
Very interesting article and comments. All credit to Jon for suggesting some real numbers – I know everyone’s situation is different but it’s all a bit vague and general without them. Surely ‘needs’ shouldn’t vary too much from person to person, almost by definition?
Personally I struggle to pick a dividing line between needs and wants as I consider it more of a continuum once you get above a warm shelter and the most basic food and water requirements. For example, if I decide to cook a steak for my dinner instead of lentil dahl should that part of my grocery bill be reclassified as a want?
Using my own spending records I can see that it’s quite possible for a couple to live on well under £1,000 a month, and that includes running a car, going on holiday and occasionally eating out.
If that’s the case then it makes a monumental difference to retirement planning in terms of how much you need to save and the age at which you retire, although it would certainly be wise to include a contingency for the situations that Vanguardfan describes.
These figures are for a couple. Where you live will also have a very large impact and it helps if your partner buys into it. I encourage everyone to read the MMM (Mr Money Moustache) USA blog. That guy is someone to aspire to. Although I think early retirement maybe much easier to do in USA – lower cost of living, cheaper funds, more capitalistic etc
I also think people tend to overestimate the amount you need to live on if extrapolating from working experience.
A lot of my spending while working was to save time or compensate for the daily experience, and that was even when I was in lockdown mode saving. Opportunities come to you. Holidays are smaller but more frequent. It’s hard to give enough credit to the value of time flexibility.
However, you must have sorted your mortgage/have enough invested to reliably pay your rent. Doing so gives you greater opportunity to choose the time and place of your spending, there are great savings to be had there. Once you have reduced the amount of money you *have* to spend every month, the amount of money you *choose* to spend every month goes a lot further.
I’d second Jon’s suggestion to read the MMM blog. It provides a great alternative view to the consumerist society that we currently live in, and pretty much follows the same suggestion as Ermine i.e. the amount of income you need to become financial independent is likely a lot lower than your current ‘working’ income needs.
Another good read if your interested in trying to establish how much you need (want) to live off is Lee Eisenberg’s ‘The Number’.
@ All – Great thread, it’s very interesting to read the different perspectives brought by one and all.
@ Jonny – ha ha! Spoilers 😉
@ Miccamaccamoo – the problem with the 4% ‘rule’ is that there’s plenty of evidence out there that it is far from safe. The idea with the two-pot strategy is that you are nailing that floor down as securely as possible and everything else is a bonus. You’re absolutely right, that a drawdown approach on a portfolio has more upside, but there’s a greater chance of it going wrong too. (Great name, btw).
@ Jon – I’m roughly in agreement with your numbers, though I err on the lower side for living reasonably well. Mrs Accumulator and I live pretty well on 20K per year (after tax). Once the mortgage has gone then it’ll be more like £1500 a month. If we had 2K per month after tax then we’d be spraying each other in champagne. My close relative on the other hand needs £1K per month just for her. I’d say she lives pretty well too but is coming in somewhat higher than you. So it seems like there’s a range there of say £1500 – £2500 a month for the ‘I’m doing quite nicely’ bracket. Where you fit on that spectrum depends on your frugality gene.
I do believe it’s harder for us Britishers to pull the MMM trick. Our pesky higher cost of living does change the Financial Independence maths. Of course it’s still doable and I’m still gunning for it. Totally agree about the MMM blog. So often a cheery pick-me-up when I’m slaving away for Da Man.