If I asked you what your retirement goals were, you might say you wanted as much spending money as possible. You might also say that you wanted to leave as much money as possible to your dependants. Finally, you might well add that you wanted to minimise any risk of running out of money before you die. Forget balance, you want all of these things!
They sound very reasonable goals. In fact, these goals are fundamental to retirement planning. Let’s label them “spending”, “legacy” and “risk” for short.
Unfortunately, these three goals are mutually incompatible! If we set any one goal as an absolute priority, then the other two goals will suffer. Let’s imagine prioritising each goal in turn. For simplicity, assume that you retire with a total retirement fund of £500,000.
Let’s say that you want to spend like there’s no tomorrow, and you spend a massive £250,000 per year. Assuming zero growth, your retirement fund will run out after only 2 years. Even if you assume a 62% annual growth rate on any unspent funds, it would still run out after 3 years. In other words, the risk is enormous. In addition, unless you happened to die within the first couple of years, which is highly unlikely, there’ll be nothing left for your legacy.
So maximising spending increases risk and decreases legacy.
Now let’s try to maximise your legacy instead. Firstly, you’ll need to cut down your spending to the bare minimum. Let’s suppose that you somehow manage to cut it to zero, by scrounging and being a complete miser. Now you need to maximise the potential growth of your retirement fund for the rest of your life. This will give you the best chance of leaving a large legacy. But the downside is that the higher the growth you aim for, the higher the risk of your losing money, even in the long term.
In other words, maximising legacy increases risk and decreases available spending.
Even if you take no investment risk, and you accept zero growth, then inflation will progressively eat away at the real value of your retirement fund. This will reduce both your available spending and your potential legacy.
It seems that we have no hope of achieving our goals. Whenever we improve on one, the other two suffer.
Getting the balance right
We started out by assuming that you’d stated that all three goals (spending, legacy and risk) were important to you. How would a financial adviser come up with a plan for you? The answer is that your adviser would first need to obtain more information from you. Do you have dependants? Since you included legacy as a goal, presumably you do. How important is leaving a legacy? Different people will put different value judgements on legacy. To different extents they’ll be willing to make some kind of trade-offs with their spending. What’s your attitude to financial risk? Would anything other than a guaranteed income for life leave you with sleepless nights? Alternatively, are you prepared to adapt your future spending to a certain extent in case of unfavourable investment returns?
Taking the first step
Fortunately, there’s a financial planning tool that can give you a fair idea of how to juggle these goals. It can handle far more complex scenarios than the simple example we gave earlier. EvolveMyRetirement® is known as the Intelligent Financial Planning Calculator. It understands how to balance these goals, and can optimise your spending and investment strategy to achieve a sensible balance.