My friend tells me a friend has $400,000 on his mortgage flat.
The interest rate on the loan was fixed at 1.3% p.a.
As we all know, the interest jumped to more than 4.1%.
His friend found that the interest component of his loan was $1,000 a month higher.
You may have heard of similar stories like this.
If you have been prudent with your income by ensuring a healthy savings rate, you can stomach the $ 1,000-a-month increase. If you have not, you will run into a problem.
What if You Have Already Stop Working?
It took a few moments for me to process that my friend’s friend still has income to try and make things work.
My attention turned to the retirees.
There are some who wish to stop working so much that I will walk by and sometimes hear that part of the retirement income plan includes paying down a mortgage.
I wonder if anyone ever imagines their monthly mortgage is 40% higher when they plan their retirement plan.
I wonder which adviser will tell the client: “I see that your current mortgage is $8,000 a month, but the current interest rate is low; we should bake in an additional 50% more of mortgage payment should interest jump from 1.5% to 4.0%.”
The client would look at the adviser and wonder whether that is excessively conservative.
Well, in hindsight, now we know that it is not excessively conservative.
People can still be Selective in How They Process Uncertainties like Mortgages.
If you don’t have a mortgage but are renting during retirement, you may also have the shock of your life to see your rent climbing 100%.
You may be conservative to plan for rent increases but… 100%?
So how much did your financial adviser plan for? 3% increase in rental adjustment?
Some acknowledge the presence of huge mortgage and rent increases that many have not experienced in the past 15 years.
Yet, somehow they remain optimistic that these “more extreme lower bound” do not feature in their minds.
If it did, I would have gotten more questions like: “Kyith, you know, I see these rent increases, mortgage increases, oil going negative, what are the chances of the S&P 500 dropping by 80%?”
Honestly, I cannot remember who has contextualised their questions this way.
The most common thing I hear mentioned to me are:
- “That kind of event is in a different regime altogether.”
- “We can’t always be planning for extreme events.”
- “People can always be flexible.”
Sometimes, deep down inside, I don’t know whether to laugh or cry when I hear this.
Let Me Try to Come up with Some Solution Ideas.
Look… I am not some doomsday prepper.
I am not the most optimistic person.
But I think it is realistic to wonder about the upper and lower bounds of the range of outcomes of different things, given we all experienced it in our lives. Even if you are confused about how to tackle it, that is acknowledging it may be distressful enough to concern you.
There are also extremely optimistic scenarios that we need to acknowledge can happen as well.
I named this article this way because I told my friend (who is also in the same industry) that I could not come up with solutions for all the complexities I encountered.
But I have this skill of letting problems “stew” in my brain for some time, and something may eventually come out.
So how do we tackle a significant expense that can have more extreme lower bounds?
Here is a list of planning things that may help:
- First, acknowledge that you live in a world with various outcomes (and some can be more uncommon). At least then, you can plan what you need to plan accordingly.
- You need to truly understand the importance of that lifestyle line item to you.
- Recognize that you need to make trade-offs. You may not have to make trade-offs if you are a middle-income person with $20 million.
- If the lifestyle line item is important to you, be prepared that those discretionary lifestyles will be wiped off (read: reduced completely), to pay for that lifestyle line item.
- If the lifestyle line item is not important to you, get rid of it.
- Now #4 works if your discretionary lifestyle is significant enough. Suppose you are like Kyith where you are really lean, you need to be more conservative when you are planning your portfolio capital to your income needs. (You can see that I am not asking you to prep for doomsday immediately. This is like the sixth item on this list!). #6 is an acknowledgement is that not everything can be flexible!
- My default is always to carve out an amount equivalent to the mortgage value from the net wealth of the person I am planning for. This is in case, the person can pay off the mortgage or a significant portion of the mortgage (like an interest increase from 1.3% to 4.1%!)
- Having an emergency fund helps. It may allow you to last 6 to 8 months for additional bandwidth on what you should do.
A person that genuinely understands that there is a range of outcomes, what is essential and less necessary to them, and acknowledges that they need to make trade-offs will likely come up with a sensible plan that survives an ordeal like this better.
Problems like this are essentially quite challenging, given our limited resources and even more challenging if we don’t have an income. Whether you like it or not, leaning towards greater conservatism is always better because of the unique dynamics of retirement.
Income is addictive.
Income corrects a lot of problems and mistakes you make.
Perhaps because of having an income, some uncomfortableness and hidden challenges are closed off to you as well. Perhaps the better planners are the people who have stopped taking external income before.
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