This week is pretty much drained. So I don’t have any bandwidth to explore things that are new. Weekends is probably to catch some breath.
One of my reader that I met up with some time ago asked me these 2 deeper question about retirement:
- What amount of principal will you feel comfortable to quit the job & just collect investment dividends, with a not-too-spendthrift lifestyle?
- How much to “reserve” for medical costs?
I thought it is easier to tackle in this week that requires some decompression.
A Framework to Think about Whether You are Ready for Retirement
Before I shared my answer to some of the questions, I would like to give a shout out to a reader (a different one from above) I met this week.
Sometimes talking to others interested who are interested in similar stuff, would make you realize a perspective that you didn’t think of in the past. So I got to thank him for that.
My reader, in a spectrum of Singapore wealth, put himself in a good position to consider retirement. I find that he has taken care of a few aspect that others would have been struggling with. So the questions are more deeper and harder to give an answer.
Both readers (this and the one asking the question above) questions all revolve around true retirement readiness.
True retirement readiness is not some 10 to 15 item article that after you go through them, you still feel something is missing. It is that if you get passed those hurdles, you should be ready to pull the plug.
It has to be said, that this is for the risk adverse. Because for the risk seeking, don’t like their job, or when the work pain gets much higher than the threshold, they just pull the plug without thinking so much.
I do not profess I have the answer, but this is what I thought about:
This is roughly how I would explain it.
1. Your True Financial Situation
Suppose we know the true state of our financial situation, we take an important step towards retirement.
In true state, you know
- the exact lifestyle that you want in retirement
- how your expenses change over your retirement
- what are the unexpected expenses, or lifestyle that will occur in a few different people’s retirement
- the true state of your financial assets and liabilities
- the interest you have to pay for the debt
- to a high degree, you know the compounded rate of return of your wealth.
When you know the true state, if the retirement mathematics work out for you, this takes care of the mathematics side of things.
2. The Non Monetary Aspects
A lot of people consider the non monetary aspect of retirement to be easy.
The non monetary aspect could be
- whether you made peace with your professional identity
- how the society looked at you
- what you are going to do for the next phase of your life
- have you been responsible to those who helped you professionally
These items are needed to be considered. Less careful considerations may mean returning to the work force. These are not deal breaking, or life ruining.
3. Your Experience with Wealth Management
My conversation with my reader made me realize the wealth management part is rather crucial.
I realize in some of the past conversations with others, a common problem was finding out a better way to accumulate wealth, or an appropriate way of investing so that it is more conducive for retirement spending.
He has been living with his investing strategy for the past 6 to 8 years. It is one which is based on portfolio allocation and delegating the investing to fund managers.
I do find that he is more ready for this because he is comfortable living with this way of wealth accumulation. This method of investing is also more sensible in spending for retirement.
Without talking to my reader, I failed to realize that one of the reasons why I think this (financial independence) is doable is because I have been investing for years. To extend this into retirement, this looks doable still.
For others, I realize they have the net wealth. However, they are uncomfortable with the way they allocate their net wealth. It is either not high return enough, or it does not cash flow enough.
If we recommend a new investing method that meet the criteria, they will have the uncertainty whether the returns, the volatility will work as advertised.
This uncertainty will make them second guess whether they are ready.
What would retirement feel like if you have not taken care of these three aspect?
There will be different degree of comfortableness living in retirement.
For some, they might eventually become comfortable with this way of investing and getting their retirement cash flow this way. For some, they might just felt that what they have chosen is not sustainable.
If your financial situation is not the true situation, you might suddenly realize there are too much things you have not factored in, your spending is too much and you will need to go back to work soon.
We have briefly went through the non monetary aspects and I think that is enough.
Of course, it may turned out that your true financial situation and investing strategy are really sound, then your retirement would be better than you have anticipated.
Would a Financial Planner Helped?
The financial planner would take care of helping you assess your financial situation. Whether the assessment tells a person the true state of their retirement readiness, I feel, is a matter of competency.
My personal opinion is that non of us can find this true financial situation. If we can consider a lot of realistic scenarios and our numbers looked OK, then it is good to go.
The world is constantly changing, your life is always evolving, so all these parameters will keep changing. Someone sophisticated enough will considered enough and explain to you that you should be ready or not.
My belief is that not many will give a good view of your financial situation.
You could delegate the investments portion away to a professional. However, you will have to learn to live with such an arrangement. Delegating away solves the investing stuff, but you may not know how to live with investing this way.
When your adviser reports this fund and that fund dropped 20% and 30% respectively, what do you do? Those who learn to live with it, gain competency, would be able to make a decision to switch or to stay with the fund. Those who have not learn enough would get really edgy with their retirement.
Some advisers who have enough experience would be able to make you appreciate the non monetary aspect of things. However, I think for that portion it is best for you to figure out yourself.
What amount of principal will you feel comfortable to quit the job & just collect investment dividends, with a not-too-spendthrift lifestyle?
My answer to this question is unique for myself and might not work for others because my:
- the way of investing is different from you
- financial situation is different
- the non-monetary aspect is different
I went from being very spreadsheet based to just figuring out with withdrawal rates.
It is very simple. Every month, if the portfolio value change, I can just look at the withdrawal rate and know this is OK, this is not OK.
Very simple. Don’t need complex spreadsheet. I can do that because… let me just say I looked at enough Monte Carlo simulations, withdrawal rates arguments, historical simulations that it affected me this way.
No professional will tell you with a single ratio, you are financially ready. So it only works for me.
So here is a rough fast walk through of how I do it:
1. Appreciate your Lifestyle and Expenses
To even begin this you need to know your expenses and lifestyle well. You can take a look at my past annual expense reports.
If you don’t know your expenses or lifestyle, think don’t bother to continue to read this.
2. Categorize your expenses into 4 categories
Your expenses can be broken up into the following categories:
- Non-Recurring Essential Expenses
- Non-Recurring Non Essential Expenses
- Recurring Essential Expenses
- Recurring Non Essential Expenses
The Non-essential expenses, they are good to have. If your portfolio is not doing well, cut them by 25%, 50%, 75%. If it does well, boost them or take harvest of this so that you can spend it when times are not good.
The essential expenses, you have to make sure that they are there.
The non-recurring expenses are not going to take place every year. In other countries, roof needs to be replaced. Locally, your home needs a 15 year once renovation for example. These are essential but non-recurring.
Even healthcare can be considered non-recurring.
For the non-recurring expenses, figure out the present value of these non-recurring expenses. I will go through this later with the medical sinking fund question.
3. Create a few Lifestyle Schemes
Once you figure this out, create a few lifestyle schemes for the expenses.
I created the following:
- Survival: Recurring essential expenses only
- Baseline: Recurring essential expenses + 25% of recurring non-essential expenses
- Current: Recurring essential expenses + recurring non-essential expenses
Survival is for me to figure out in the worst of the worst case, whether I can survive as a human being. Baseline is a lifestyle that I feel comfortable in living for a long time. Current is how I am living now.
If you need to live like what it is like currently in retirement then #3 will be the most important for you.
You can create a few other schemes, depend on what you prefer.
From what I read, and my observation, a lot of us think we will live the same way as when we are working. That might not be true.
To come up with a scheme, remove the money part. Take yourself through what you will do 30 days in retirement. Then come up with the cost for it. This may be a scheme that you can use to estimate how much you need for retirement.
4. Deduct the liabilities from your portfolio
When you go through the expenses and find the non-recurring essential and non-essential expenses, these are the contingent liabilities that you need to set aside money for.
This will come from your net wealth, or from insurance.
For example, you can compute the present value of all your vacations. They are likely non-essential and non-recurring. Then you can get the present value.
If you are adverse to dementia and would like to prepare for it, estimate when you will get it and for how long. Get the present value for this.
Take your net wealth, deduct these 2 present value (vacation and dementia) from it.
5.Calculate the initial withdrawal rate from the net wealth
For those 3 schemes (Survival, Baseline, Current), you can take the annual expenses / net wealth left after deducting the liabilities.
If your withdrawal rate is low enough for you, congratulations, you are ready numbers wise.
To circle back to my original framework, you probably have to take care of the wealth management and non-monetary aspects.
This table below shows the decision tree whether you are ready to retire or not, and if not, what is the recommendation:
My Withdrawal Numbers:
The Survival Withdrawal Rate is probably 1%.
The Baseline Withdrawal Rate is probably 1.3%.
The Current Withdrawal Rate is probably 1.7%.
Do note that I have not deduct much non-recurring expenses. I treat most of the expenses as recurring. What this means is that the numbers might look a little different.
You can look up that decision tree chart above to see what are the recommendation for myself.
Typically, the recommendation is to ensure you are able to guarantee to have a cash flow for your survival expenses. This will mean you have a withdrawal rate of 3% or less. If you are conservative, the baseline withdrawal rate can aim to be less than 4% if your essential expenses are covered well below 3% ( this will mean you spent nearly 1% on 25% of your non-essential recurring expenses)
Medical Sinking Fund
The question of medical sinking fund is damn tough.
Medical budgeting is so tough that even Lee Kuan Yew School of Public Policy took it out of their paper. (Read this)
As a planner, you have no choice but to try and model this, if you feel that you need to factor this in.
I would break up the expenses into:
- Recurring essentials: The medicine you have to take daily in order for your condition not to become bad, insurance premiums
- Recurring non-essentials: The supplements that are good to have
- Non-recurring essentials: The medical sinking fund for conditions that are likely to happen in the future.
- Non-recurring non-essentials: if there is any
The recurring portions will go into the expense schemes I have explained previously.
Determining the Non-Recurring Essentials
I thought about this at work and it can be rather tough to determine. Do you just keep adding so many contingent liabilities?
An adviser shared with me that if you get disabled, a lot of the other expenses might come down. If you keep adding these contingent liabilities together, think you can continue to work in an unhappy job for a long time.
Dementia Case Study
Likely we cannot find out the true costs. But if you have medical professional as friends, you can find out the probabilities, frequency of occurrences, and how much it costs.
Then you can get the present value, figure out the rough amount you need today.
For example, you are 41 years old. Suppose someone similar tomorrow gets dementia and needs to be admitted to a nursing home.
This form of estimation is probably the most extreme. The idea is that, if you managed to provide for this scenario, you should be able to take care of the smaller ones.
Typical cost of nursing home comes up to $4,000 a month (if there are vacancies). That will be $48,000 a year. Suppose you are worried about inflation. Use 7% inflation. We invest the rest of the money in a portfolio that compounds at 4.5% a year. We estimate that this dementia patient survives for 60 years.
I found this awesome spreadsheet calculator and it gives the following result:
The awesome thing about this calculator is that it computes the payment at a different rate of growth from the investment rate of return, and when the payment is differed for a number of years.
The formula for present value is this:
=p*IF(i=k,(1/(1+i))^t*n,(1/(1+i))^t*((1-((1+k)/(1+i))^n) / (1-(1+k)/(1+i))))
In our base case, you will need a sinking fund of $6.3 mil.
Suppose you buy some disability insurance which hopefully covers this when you are before 65 years old. We differ the need for this payout by 25 years and we need the money for 35 years.
The present value is lower at $860,000.
If we estimate that onset of dementia happens after 65 and last for 10 years, the figures work out like this:
The sum becomes more manageable.
I feel it is better to figure out roughly how much you need. Like what my adviser friend said, your expenses may be cut down when you are this disabled. The net wealth can go to fund for this scenario.
Hospitalization Case Study
We do not know when we will be hospitalized. Each of us have different genetic profile. Some of us have pre-existing illnesses and so the frequency of future hospitalization are also different.
My suggestion is to plan out a few scenarios and see what is the sinking fund amount you can get to. Then you set aside this amount as a sinking fund.
Suppose we estimate that within a 60 year period, you will have 3 different levels of hospitalization:
- Small: $3000 per visit
- Medium: $30,000 per visit
- Large: $300,000 per visit
This is before your hospitalization and surgical plan, or your shield plan. You will need to pay a deductible and a 10% co-payment at the minimum. Let us assume the deductible to be $3,000.
If we assume medical cost go up by 7%, you can come up with the following:
We can see the year, age, deductible paid, the size of the actual bill for small, medium and large problems, adjusted for inflation. Then, we can work out the total deductible plus co-payment required.
Approximate the value back to present value in the last column.
This figure comes up to $289,000 in present value. Readers let me know if you have such a frequency of medical hospitalization. Every 15 years, there is a major surgery. Every few years there is a big one.
If you have $52,000 in your CPF Medisave, it means you need $237,000 more.
You can vary the frequency. What I can share with you is that, the small problem don’t move the needle.
Removing the major illnesses costing $2 mil and $6 mil cuts the present value needed to $124,000. Removing all the medium problems cut the amount to $66,000.
Play around enough, and you would have an appreciation how many major and medium problems you need to cater for.
This took longer than expected. However, I felt it was a nice exercise to go through trying to find out how much does our future medical cost will be in today’s dollars.
I will probably expand on the medical sinking fund idea, either here or in a work article of mine.
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