How much risk do I NEED to take?

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RandyAdams1978
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How much risk do I NEED to take?

Post by RandyAdams1978 »

I'm not even sure if I'm going to ask the right question .... but here's my situation.

I'm 53. Wife is 42. I currently have about 400K in retirement funds. My goal is 1M by the time I retire at age 67. I estimate that my wife and I will be contributing an additional 350K over the remainder of our working life times. With no return, that would put us at about 750K at retirement.

Further, I've estimated that if I get a 3% return on my money --- current investments as well as future contributions --- the total account value would be just over 1M (1,014,405 per my Excel spreadsheet).

What does that say about the kind of risks I need to be taking? And, I guess the follow-up question would be, what kind of AA does that point towards?

I have no SV fund in my 401k.
Johm221122
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Re: How much risk do I NEED to take?

Post by Johm221122 »

I would start with age in bonds or age -10 in bonds.I personally would start lean towards 63% stocks.Reading WIKI (top right) for assset allocation is great source of information.You may want to factor in wife's younger age
John
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Thanks John. But doesn't that allocation to stocks seem a bit high? I'm only trying to get 3% a year.
livesoft
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Re: How much risk do I NEED to take?

Post by livesoft »

I wonder if you have ever read Larry Swedroe's "The Only Guide You'll Ever Need for the Right Financial Plan: Managing Your Wealth, Risk, and Investments" which goes over in a helpful way his "need, ability, and willingness to take risk" that he coined decades ago.

I cannot quote from it since I read a library copy, but I found it very helpful in explaining all this need for risk stuff, so I think it might help you, too.

Something else that might be helpful is to use calculator at http://www.FIRECalc.com In the "Investigate" tab, one can select
Investigate changing my allocation
How will changing the allocation -- putting more or less into stocks -- affect the results?
which will plot percent equities versus success. This will pretty much tell you directly what the minimum allocation to equities should be for the situation (i.e. YOUR situation) that you enter in the other tabs.
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Re: How much risk do I NEED to take?

Post by z3r0c00l »

RandyAdams1978 wrote:Thanks John. But doesn't that allocation to stocks seem a bit high? I'm only trying to get 3% a year.
100% stocks may not even get there. 3% is not as easy as one might think, especially after taxes and inflation.
70% Global Stocks / 30% Bonds
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Re: How much risk do I NEED to take?

Post by The Wizard »

RandyAdams1978 wrote:Thanks John. But doesn't that allocation to stocks seem a bit high? I'm only trying to get 3% a year.
3% a year is essentially what inflation has been recently; you're not going to get much (any?) real growth with that rate.
If you need $1M in 14 years, it might be better to aim higher and achieve that goal earlier and/or get to $1.2M at your age 67. This is partly because of the risk that INFLATION might be a bigger issue down the road than it is now.
A 50/50 AA, properly managed, should get you to your goal with the numbers you mention.
What is your AA at present?
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Re: How much risk do I NEED to take?

Post by The Wizard »

z3r0c00l wrote:
RandyAdams1978 wrote:Thanks John. But doesn't that allocation to stocks seem a bit high? I'm only trying to get 3% a year.
100% stocks may not even get there. 3% is not as easy as one might think, especially after taxes and inflation.
Taxes may not be an issue if much of their accum is tax-sheltered.
And it doesn't seem like the OP is accounting for inflation yet, just targeting the $1M figure...
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Johm221122
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Re: How much risk do I NEED to take?

Post by Johm221122 »

RandyAdams1978 wrote:Thanks John. But doesn't that allocation to stocks seem a bit high? I'm only trying to get 3% a year.
Inflation and current interest rates is the reasons for high equity allocation suggestion
John
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Re: How much risk do I NEED to take?

Post by Call_Me_Op »

What will that 1 million be worth in today's dollars in 14 years? At 3% inflation, the answer is $660k. You need to decide if that is enough.
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Re: How much risk do I NEED to take?

Post by stemikger »

Bumping for later.
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Re: How much risk do I NEED to take?

Post by Johm221122 »

Let's not forget wife's age
John
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Re: How much risk do I NEED to take?

Post by Bustoff »

Many suggest your personal risk tolerance should be the greater consideration. How you reacted in 2008 should give you a good indication of your true risk tolerance.

You also need to anticipate your annual expenses in retirement in order to determine your NEED to take risk.
If you have $750,000 at 67 years of age and live another 20 years, that $750k will provide roughly $37,500 per year (not considering taxes and effects of inflation). If you add another $18,000/year in SS, that gets you to $56,500.
To get to an additional 20K a year, you need $400,000 more in your nest egg. That means doubling your current $400K !
Bear in mind this is all based on only 20 years worth of withdrawals and doesn't take into account the additional drawdown years needed by your spouse.
Rather than trying to force your portfolio into a specific performance level you could simply save as much as humanly possible, invest moderately and forget about it. If your really lucky, you and your spouse will remain employed and most importantly, healthy.
Last edited by Bustoff on Thu Sep 19, 2013 7:24 am, edited 1 time in total.
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Wizard: My current AA is about 50/50. I'm giving myself until the end of this calendar year to come up with a plan going forward. Thanks.

livesoft: I have a copy of that book in my nightstand. As I recall, the pages devoted to risk need talk mostly about "stop playing the game if you've already won". I'll have to re-read it, but I don't recall specifics being there on how to assess one's need to take risk. And maybe I'm being unreasonable, but I'm hoping to translate some risk need figure into an appropriate AA.

All: you are right on the inflation point. That is completely missing from my calculations. Back to the drawing board ....

More info... my calculations on how much I need when I retirement fall in between the 800K mark and the 1.2M level. I used 1M here just because it's the midpoint of those values. Thanks.
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Re: How much risk do I NEED to take?

Post by bobcat2 »

Why is your goal $1 million? Such a round number sounds suspiciously arbitrary, particularly if it is in nominal, rather than real dollars.

More broadly, assuming your ultimate goal is a safe and comfortable retirement, your financial goal should be in retirement income per year, not a level of financial wealth at retirement. For example, a more reasonable goal would be $70,000 real (today's dollars) per year in retirement from all sources, including SS and pensions, rather than $1 million in financial wealth at retirement. This brings more financial tools into play such as when to take SS and the trade offs involved in saving more (or less) and retiring earlier (or later). If getting to $70,000 per year involves taking a lot of financial risk (high allocation to stocks) you might also want to pick a second and lower retirement income goal that will be safely financed by relatively safe assets including SS. This lower income goal you should be able to achieve with very high probability and be the floor retirement income that is acceptable to you in case your risky assets head south between now and retirement.

It is important to realize that a level of wealth and a stream of income are not simply two interchangeable ways to look at your retirement goal. Here is a succinct explanation of that important distinction by Nobel prize winning economist Bob Merton.
Confusing the need for a pot of money with the need for income can lead to very expensive mistakes.“You cannot say wealth goals are approximate to income goals. Imagine you are a 45 year old and you are going to retire at 65. In returns of income, what is the risk free asset? It is an asset, fully guaranteed, that 20 years from now starts paying you a level income for the rest of your life, corrected for inflation. I created one of those, called a real annuity, and from 2003 to 2012 I ploughed the monthly returns and we saw swings of -17 per cent and +15 per cent, on a risk-free asset. Yet when you measure this asset in terms of income, there’s no risk. So when someone says we can approximate an income goal with a wealth goal, as a practical matter, it doesn’t even come close,” says Merton.

“Or since 2008, suppose someone was lucky enough to have £1m to live off. If they had been very conservative and had bought bank CDs, six or seven years ago they would have told you their income was 4.5 or 5 per cent and they would have got £45,000 to £50,000 a year. Now you say to them, congratulations, I have preserved your £1m. But they say, yes and I am getting £4,000 to £5,000 a year. I can’t live on that,” he adds.
In terms of risk, remember that you have risk capacity and risk tolerance and that risk capacity takes precedence. Briefly your risk capacity consists of objective measures of your risk profile such as do you have a lot of debt, do you have a secure job, do you have a reserve or emergency fund, are you healthy, do you own or rent, if you own is the mortgage paid, etc. Risk tolerance is how you feel about risk and plays a secondary role. If you don't have the risk capacity, it doesn't matter how risk tolerant you are, you don't have the capacity to take on risk. Since you are in your 50s, you don't have a lot of earnings years left, so your risk capacity is somewhat limited, unless you or wife are willing to work for several years after you turn 67.

Instead of thinking in terms of need to take risk, keep in mind the following. If you are falling short of your retirement income goal there are only three ways to improve the chances of getting there: Save more (and consume less) now, work longer (retire later), or take more risk (and accept a larger shortfall in the event you do not succeed).

The best way I know to target your retirement income goal is to price the cost of an inflation-indexed life annuity at your retirement age (age 67 in your case). Then devise a strategy (that includes maximizing SS and pension income) that gets you to that goal with the minimum amount of financial risk. Keep in mind that the level of assets needed to reach the goal will vary over time with changes in real interest rates and changes in longevity at retirement. That is the primary reason targeting a level of wealth at retirement instead of a stream of income is a bad idea.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Bustoff: I didn't do anything in 2008. But that was more like a deer in the headlights reaction than anything else.
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Re: How much risk do I NEED to take?

Post by Bustoff »

bobcat2 wrote: The best way I know to target your retirement income goal is to price the cost of an inflation-indexed life annuity at your retirement age
BobK
Hi Bob - I would like to try your suggestion. Can you advise where we can get the cost information for inflation-indexed life annuity at retirement age ?

Thanks
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

bobcat: I will have to read (and digest) later. The 1M was the midway point between 800K and 1.2M -- which is the range I've calculated as needing. you're 70K example is nearly spot on to what I've been playing with. I've been targeting 60K in today's dollars.

I also have a pension (not indexed for inflation). It will pay about 30K/yr.

SS is going to be about 35K/yr

At 60K per yer in today's dollars, I'm likely going to need 100K or more starting 2028.

I'll have to double-check these numbers when I get home -- I'm at work now.

Thanks!
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Re: How much risk do I NEED to take?

Post by bobcat2 »

Bustoff wrote:
bobcat2 wrote: The best way I know to target your retirement income goal is to price the cost of an inflation-indexed life annuity at your retirement age
BobK
Hi Bob - I would like to try your suggestion. Can you advise where we can get the cost information for inflation-indexed life annuity at retirement age ?

Thanks
The Income Solutions life annuity portal at Vanguard. I believe there are currently two insurance companies at Income Solutions that offer real life annuities. Simply price a real life annuity today, not at your current age, but at your intended retirement age. If you are married price a joint real life annuity at the ages of you and your spouse at your intended retirement date.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
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Re: How much risk do I NEED to take?

Post by livesoft »

RandyAdams1978 wrote:livesoft: I have a copy of that book in my nightstand. As I recall, the pages devoted to risk need talk mostly about "stop playing the game if you've already won". I'll have to re-read it, but I don't recall specifics being there on how to assess one's need to take risk. And maybe I'm being unreasonable, but I'm hoping to translate some risk need figure into an appropriate AA.
Well then perhaps I am confusing it with something else. I had thought that Mr Swedroe's book was the source of something like this:
If you start with $V and want $X by Y years and can add $Z per year, you will need to have W% real return to make it. If you NEED W% real return to make it, then look at the return of stocks and bonds and select a ratio of stocks:bonds that has generated W% real return over that Y years with a reasonable probability of success. If you don't use at least that ratio of stocks:bonds, then you have no chance. That pretty well defines your NEED to have that asset allocation and that risk of that fraction of equities. Any lower fraction of stocks and you are gonna have a much lower probability of success.

Here is something similar from Paul Merriman with a table of asset allocations versus return at the end: http://www.merriman.com/wp-content/uplo ... ng2011.pdf
Here is a more updated table:
http://paulmerriman.com/fine-tuning-asset-allocations/ and the associated podcast: http://paulmerriman.com/2013/07/31/fine ... llocation/
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Bobcat: "and from 2003 to 2012 I ploughed the monthly returns and we saw swings of -17 per cent and +15 per cent, on a risk-free asset."

I don't understand what this means. What is "ploughed"?

livesoft:

What you laid out seems reasonable, but I wish that table went back farther for bonds. Although, now that I think of it, the 70's were rising interest rates, right? The great bond bull market didn't start until around 1980, I believe.
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Re: How much risk do I NEED to take?

Post by letsgobobby »

$1M in today's dollars, or in nominal dollars? I haven't attempted to replicate your math.

FWIW, in my own portfolio, I am anticipating the following long-term gains:

0% real in total bond market (given starting point of SEC yield around 2% and inflation around 2% - both very roughly)
4% real in stocks (given starting point of PE10 24)

so if you need 3% real, then using my numbers, you'd want 75/25.

If you only need 0% real, then you could be all in bonds, though more practically/less extremely 25/75 is safer.

However these are very wild guesses. As others have alluded to, excessive precision leads to a false sense of security.

It's probably a better strategy to pick the AA you are most comfortable with, and then adjust your savings rate to meet your financial goals. That's what we do. We are only 60/40, low need to take risk, but just generally 'conservative' types, and so we adjust upward our savings rate accordingly to meet our long term financial goals.
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Re: How much risk do I NEED to take?

Post by bobcat2 »

RandyAdams1978 wrote:Bobcat: "and from 2003 to 2012 I ploughed the monthly returns and we saw swings of -17 per cent and +15 per cent, on a risk-free asset."

I don't understand what this means. What is "ploughed"?
Merton is saying that the closest thing to a risk-free asset for retirement would be a deferred inflation-indexed life annuity that you would buy years before you retire. Such an asset doesn't exist in the US but Merton, thru financial engineering, could price a hypothetical deferred life annuity through time. What happened when he did that was that it had wide swings in value before retirement, primarily because of changes in real interest rates, changes in life expectancy at retirement, and changes in inflation rates. So the asset (the real life annuity) is very low risk in hitting the retirement income goal once you get to retirement, but varies considerably year to year in price prior to retirement.

Merton's point is that a low risk asset for income in retirement varies in price prior to retirement so that if you are planning for low risk income in retirement you should not pick as your financial target a level of wealth at retirement. That level of wealth will change over time due to changes in real interest rates, life expectancy, and inflation rates.

Merton was being interviewed for a British financial magazine for the quote. In England plowed is spelled ploughed. One of the meanings of the verb plow (plough) is to invest money in substantial amounts. So Merton when investing the monthly returns of his safe deferred life annuity before retirement, saw wide swings in those returns. The very safe retirement income asset looked very risky held during the years prior to retirement.

Here is a link to the article - http://www.moneymarketing.co.uk/channel ... 78.article

BobK
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Re: How much risk do I NEED to take?

Post by Fallible »

Bustoff wrote:Many suggest your personal risk tolerance should be the greater consideration. How you reacted in 2008 should give you a good indication of your true risk tolerance. ...
I agree, simply because if you haven't correctly determined your emotional tolerance for risk (it's not easy and it can change), and if your asset allocation is not ultimately based on that tolerance, you most likely won't be able to stay the course in a market crash or even an extended down market.

And speaking of 2008, here's a forum topic from Taylor Larimore on lessons learned from the '08 crash, with frequent mention of risk tolerance:

http://www.bogleheads.org/forum/viewtop ... 0&t=117687
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Re: How much risk do I NEED to take?

Post by HomerJ »

RandyAdams1978 wrote:bobcat: I will have to read (and digest) later. The 1M was the midway point between 800K and 1.2M -- which is the range I've calculated as needing. you're 70K example is nearly spot on to what I've been playing with. I've been targeting 60K in today's dollars.

I also have a pension (not indexed for inflation). It will pay about 30K/yr.

SS is going to be about 35K/yr

At 60K per yer in today's dollars, I'm likely going to need 100K or more starting 2028.

I'll have to double-check these numbers when I get home -- I'm at work now.

Thanks!
SS is indexed for inflation, so if you're shooting for 60k in today's dollars, and SS will cover 35k of that, then you only need 25k in today's dollars...

In 14 years, asumming 3% inflation, that will be around $40k in future dollars you'll need...

Your pension will cover $30k of that...

You only need $10k a year in future dollars from your investments. So you need about $250k... Heck, let's make it $500k and give yourself a nice buffer. Which you'll get even if you save ZERO from now on.

I think you've won the game. 50/50 is fine for you. Drop to 40/60 when you hit 60, and 30/70 at age 70 and stay there (age in bonds)
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Re: How much risk do I NEED to take?

Post by blueridge »

HomerJ wrote:
RandyAdams1978 wrote:bobcat: I will have to read (and digest) later. The 1M was the midway point between 800K and 1.2M -- which is the range I've calculated as needing. you're 70K example is nearly spot on to what I've been playing with. I've been targeting 60K in today's dollars.

I also have a pension (not indexed for inflation). It will pay about 30K/yr.

SS is going to be about 35K/yr

At 60K per yer in today's dollars, I'm likely going to need 100K or more starting 2028.

I'll have to double-check these numbers when I get home -- I'm at work now.

Thanks!
SS is indexed for inflation, so if you're shooting for 60k in today's dollars, and SS will cover 35k of that, then you only need 25k in today's dollars...

In 14 years, asumming 3% inflation, that will be around $40k in future dollars you'll need...

Your pension will cover $30k of that...

You only need $10k a year in future dollars from your investments. So you need about $250k... Heck, let's make it $500k and give yourself a nice buffer. Which you'll get even if you save ZERO from now on.

I think you've won the game. 50/50 is fine for you.
Big +1. For those who will be getting a reasonable SS benefit (i.e. those who have worked enough years at a high enough salary), retirement is much more obtainable than many people realize. I can live off of 3.8% of my current portfolio. I can live off of 0.9% of my current portfolio once I'm drawing SS.
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Re: How much risk do I NEED to take?

Post by HomerJ »

blueridge wrote:For those who will be getting a reasonable SS benefit (i.e. those who have worked enough years at a high enough salary), retirement is much more obtainable than many people realize.
Yep, my wife and I will be getting around $2000 a month EACH...

That's $48k a year in real dollars.

Since we currently have expenses of about $70k a year (our house is paid off), and that's with a kid still at home, retirement doesn't look too hard...
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Re: How much risk do I NEED to take?

Post by bobcat2 »

HomerJ wrote:
RandyAdams1978 wrote:bobcat: I will have to read (and digest) later. The 1M was the midway point between 800K and 1.2M -- which is the range I've calculated as needing. you're 70K example is nearly spot on to what I've been playing with. I've been targeting 60K in today's dollars.

I also have a pension (not indexed for inflation). It will pay about 30K/yr.

SS is going to be about 35K/yr

At 60K per yer in today's dollars, I'm likely going to need 100K or more starting 2028.

I'll have to double-check these numbers when I get home -- I'm at work now.

Thanks!
SS is indexed for inflation, so if you're shooting for 60k in today's dollars, and SS will cover 35k of that, then you only need 25k in today's dollars...

In 14 years, asumming 3% inflation, that will be around $40k in future dollars you'll need...

Your pension will cover $30k of that...

You only need $10k a year in future dollars from your investments. So you need about $250k... Heck, let's make it $500k and give yourself a nice buffer. Which you'll get even if you save ZERO from now on.

I think you've won the game. 50/50 is fine for you. Drop to 40/60 when you hit 60, and 30/70 at age 70 and stay there (age in bonds)
The OP can invest conservatively (much less than 50% stocks) between now and retirement and hit his retirement income goal with very high probability. Frankly, he could invest it all in TIPS bonds that mature in 14 years and I-bonds, which is about as safe as retirement investing gets, and hit his retirement income goal with as near certainty as we get in the real world. That would still leave several hundred thousand of financial assets in the portfolio beyond the amount used to fund his family's retirement income goal.

:sharebeer

BobK
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Re: How much risk do I NEED to take?

Post by Johm221122 »

If something happens to you
Does wife get pension ?
What Will wife's SS be ?
How much will wife need ?
Or do you have insurance to cover this?
You alone don't need much risk, but there are two in the equation
John
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Thanks to all who have responded. Here's the actual numbers:

If I retire at 67:

SS statement says I'm entitled to $2,533 per month if I retire at age 67. That's $30,396 per year. But's that's in today's dollars, right? That gets indexed for inflation, yes? At a 3% inflation rate, that comes out to about 46K a year starting in 2028. At 4% inflation, that equates to 52K per annum.

Pension is $3,200 a month, not indexed to inflation. But that's just for me alone. If I take the spousal option, which is highly probable, that reduces that number to about $2,650 per month, or about $32,000 per year.

I estimate my spending needs at $60,000 per year, in today's dollars. At 3% inflation, I'll need about 91K per year, starting in 2028. At 4% inflation, That number jumps to $104,000 that I'll need

Wife will get 9K per year when she hits 62, which is 20 years from now, 2033. Just in time for my SS benefits to get reduced to 75% of what I'm currently projecting. I'm not going to factor either of those in, at this point.

So... based on spending and income estimates, my shortfalls would be as follows:

3% inflation: Income need ($91,000) - SS benefit ($46,000) - pension ($32,000) = $13,000
4$ inflation : Income need ($104,000) - SS benefit ($52,000) - pension ($32,000) = $20,000

Does that sound right?

John221122L
Wife does NOT get a pension.
Wife's SS estimated to be 9K per year
Through work, I have a life insurance and long-term disability policy. I haven't peeked at the life insurance policy in a bit, but I seem to recall it paying about $100,000. The long-term disability pays 60% of salary. I have nothing outside of that.
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Re: How much risk do I NEED to take?

Post by tadamsmar »

When I do projections, I try use only real rates of return and basically ignore inflation. It works well if all your pensions are inflation adjusted. You just project real returns for your next egg rather than nominal returns. Of course, social security is inflation adjusted.

You might find financialengines.com useful, particularly since you seem to have most or all the data you will need to use it. It's a good tool for getting a feel for the risk you need to take and the savings you need to reach a nest egg size goal at retirement.
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Re: How much risk do I NEED to take?

Post by KyleAAA »

Is that $1 million in today's dollars or $1 million in future dollars? I think aiming for some nominal amount that far in the future is a bit silly because we have no idea what inflation will do between now and then. It might be 3 or 4%, but it might be much higher (or lower).
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Re: How much risk do I NEED to take?

Post by less »

The OP's second posting missed his wife's SS. Assuming 3% inflation his spending will be $91,000
His guaranteed income will be SS (46,000+9,000) plus pension (32,000) = 87,000
His investments must cover the $4,000/yr shortfall (91-87).
With a nominal (not adjusted for inflation) $1Million that means he only needs a withdrawable return of 0.4% !!!

So I would conclude that the assumption of needing $1million waaay overstates the needs. His current portfolio plus the expected savings (400,000+350,000= 750,000) even if they earn 0% would only need to generate a withdrawable return of 0.5% !!!!!
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Re: How much risk do I NEED to take?

Post by Johm221122 »

KyleAAA wrote:Is that $1 million in today's dollars or $1 million in future dollars? I think aiming for some nominal amount that far in the future is a bit silly because we have no idea what inflation will do between now and then. It might be 3 or 4%, but it might be much higher (or lower).
OP is 14 years from retirement (about same as me) When would you look at having a number?I also have number and know I have to adjust with time, but a goal is nice
John
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Re: How much risk do I NEED to take?

Post by bobcat2 »

RandyAdams1978 wrote:Thanks to all who have responded. Here's the actual numbers:

If I retire at 67:

SS statement says I'm entitled to $2,533 per month if I retire at age 67. That's $30,396 per year. But's that's in today's dollars, right? That gets indexed for inflation, yes? At a 3% inflation rate, that comes out to about 46K a year starting in 2028. At 4% inflation, that equates to 52K per annum.

Pension is $3,200 a month, not indexed to inflation. But that's just for me alone. If I take the spousal option, which is highly probable, that reduces that number to about $2,650 per month, or about $32,000 per year.

I estimate my spending needs at $60,000 per year, in today's dollars. At 3% inflation, I'll need about 91K per year, starting in 2028. At 4% inflation, That number jumps to $104,000 that I'll need

Wife will get 9K per year when she hits 62, which is 20 years from now, 2033. Just in time for my SS benefits to get reduced to 75% of what I'm currently projecting. I'm not going to factor either of those in, at this point.

So... based on spending and income estimates, my shortfalls would be as follows:

3% inflation: Income need ($91,000) - SS benefit ($46,000) - pension ($32,000) = $13,000
4$ inflation : Income need ($104,000) - SS benefit ($52,000) - pension ($32,000) = $20,000

Does that sound right?
I think your analysis would be simpler and more accurate if you did everything in real terms instead of nominal. If you do that the only adjustment you have to make when considering different inflation scenarios is to deflate the nominal pension by the inflation rate. The way you are doing it requires inflating everything but the pension by the inflation rate.

More substantively, you should be considering whether you should be delaying when you take SS benefits instead of simply blithely taking the benefits when you retire. In real terms SS benefits increase about 8% per year for every year you delay until age 70. Your wife would then get those higher benefits if you were to pass away. You should also investigate whether your pension benefits increase if you delay taking them. Sometimes they do; sometimes they don't. My pension is nominal but increases by roughly 12% per year for every year I delay.

We also don't know many other important factors about your finances such as whether you own or rent, and if you own will the mortgage be paid off by the time you retire. So we can't give complete advice, we can only comment on whether your retirement income goals can reasonably be met. It appears they can be met without taking much investment risk.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
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Re: How much risk do I NEED to take?

Post by KyleAAA »

Johm221122 wrote:
KyleAAA wrote:Is that $1 million in today's dollars or $1 million in future dollars? I think aiming for some nominal amount that far in the future is a bit silly because we have no idea what inflation will do between now and then. It might be 3 or 4%, but it might be much higher (or lower).
OP is 14 years from retirement (about same as me) When would you look at having a number?I also have number and know I have to adjust with time, but a goal is nice
John
Having a number is fine, but it should always be a constant-dollar number.
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Re: How much risk do I NEED to take?

Post by telemark »

Here's one possible approach: please note that I haven't thought this through all the way and I'm not even sure it would work.

You have 400K and an income stream, and you want to turn that into 1M in 14 years with a minimum of risk. If I've calculated this correctly (14th root of 2.5, yes?), you can do this with a 6.76% annual return on what you already have. This sounds like a job for value averaging.

Put all your new money into cash. Once a month, or once a quarter, or once a year, calculate what the value of your portfolio would be with a constant 6.76 APY, and add enough money from your saved cash to get it there. If it's already above that, and if this is in a tax-sheltered account, take out the excess and put it into something safe (stable value, money market, whatever is available). In effect you are constantly adjusting your risk level up and down as the market fluctuates.

Again, this is not intended as a serious recommendation, but I'm curious what other people here think of the idea.
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Re: How much risk do I NEED to take?

Post by Watty »

My goal is 1M by the time I retire at age 67.
You have investing risks but you also have other risks.

One big risk that you have is that something will happen and you will have to retire before then.

One thing to consider how your numbers would look if you invested as if you would need the money to retire at 62. That could give you a margin of safety so that needed to retire early or if your investments perform poorly then you have some time to recover.

There would be a tradeoff between having to take some more investing risks in order to reduce other risks.
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Good morning. I appreciate all the feedback. You folks are incredible.

bobcat: Yes, I need to investigate pension options. I know there's a fairly significant penalty for tapping into the pension prior to turning 65. I believe the reduction is 6% per year. Not sure if there's a benefit to delaying. I will ask.

I own my house, and have about 25K left on mortgage. It will be paid off by retirement. Or, at least, that's the plan.

I also have college money set aside for three children:
Earmarked for Child 1 (HS class of 2017): $100K in CD's
Earmarked for Child 2 (HS class of 2019): $100K in munis
Earmarked for Child 3 (HS class of 2023): 529 accounts in all 3 kids names; contributing only up to tax benefit amount, which is $2K per year per child (Ohio). Will eventually transfer all accounts to her name only.

The local HS has programs that allow HS students to earn up to 2 years of college credits while in high school. That is at no additional cost. Also, there are fine area Community Colleges that allow full transfer of credits to 4 year schools.
It may or may not pay all their expenses, but the bucket has been filled as much as I'm going to fill it.

Homer/bobcat
To those who say that I've already won the game ... hmmmm ... maybe. IF inflation stays in check, ... probably? But the shortfalls I noted earlier are for the first year of retirement ONLY. Because my pension is NOT indexed to inflation, those shortfalls increase every year. And, if inflation gets really high, those shortfalls become ... well, ... really high.

Maybe my calculations are off. Maybe I'm doing something incredibly wrong.
Here's what I'm doing:

1) Income need in today's dollars is $60K. Year one for my calculations is 2014. Let's assume 3% inflation. In 2028 (1st year of full retirement), income need is $90,755
2) SS currently estimates paying $2,533/month at age 67. That's $30,396 per year in today's dollars. At 3% inflation, that becomes $45,977 in 2028 (is this how it will work?)
3) Pension is $31,872 annually. Not indexed to inflation.
4) In 2028, shortfall is $12,907; in 2029, it's $14,250;
5) I've factored in 25% reduction in SS benefits starting in 2033. That's my understanding of the SS depts' estimate of when and how much benefits will be reduced.
6) In 2033, wife starts collecting SS; overall shortfall in 2035 is $20,594
7) Shortfall continues to increase annually from there on out...
8) I'm calculating we both live to 85. That's it. After that, we ARE a burden to our children. Or society. Or both.
9) The total cumulative shortfall after all this is $877,064. Again, this is for 60K income and 3% inflation.
10) Nudge inflation up to 4%, and the total cumulative shortfall is $1,399,637
11) On the flip side, if inflation remains tame -- say 2.5% --- the TCS is $667,488.

Where do I go from that number? Or, should I not be calculating TCS at all?
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Re: How much risk do I NEED to take?

Post by Dandy »

Unfortunately, a million today isn't what it used to be and in 14 years even less. But, a million is pretty good. I think you need to think about estimated retirement expenses and how much of your portfolio you will need each year. Will either of you have a pension or SS? House paid for? other debts? How is the cost of living where you live? Will you have to relocate? Getting a feel for this will help you understand any decisions you need to make near term.

Let's assume you have a million and can take 4% a year to start - that is $40,000. Is that in the ball park for supporting you in retirement? Can you wait till 70 to take SS and get the max benefit?

If a million seems to be workable for you then I would shoot for a moderate equity allocation of 50-60% with a goal to get to 40 to 50% about 5 years from retirement. I would suggest the fixed income side be short term bond funds and investments that don't lose value (e.g. CDs, I bonds, EE bonds other bank FDIC products). When interest rates rise you can either move some of the no risk money into short or intermediate bond funds or keep renewing your "safe" fixed investments.

For equities I would use the Total Stock Market and total International Stock market. So a portfolio something like this; 40% Total Stock, 20% total int' stock, 10% Short term bond index, 10% short term investment grade bond fund, 20% CDs, other safe vehicles.

If a million doesn't seem enough I would cut current expenses and save more rather than ramp up the risk. To me taking a lot more risk to get a higher number isn't worth it. I'd rather cut expenses and try to reach the goal that way.
Good luck
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Watty
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Re: How much risk do I NEED to take?

Post by Watty »

Maybe my calculations are off. Maybe I'm doing something incredibly wrong.
Your calculations are way too complex and they could give you a false feeling that you know how things will really play out.

Since there are so many unknowns a simple back of the envelope calculation is just about as likely to be right as a three page spreadsheet that has at least a half a dozen assumptions built into it.

What I do is to do all my calculations in current(non inflation adjusted) numbers but I state my expected future investments earnings in real(after inflation) numbers. For example instead of stating that I was planning on 3% inflation and getting a 5% after tax investing return, I would plan everything bases on a 2% real rate of return. The only thing that would not work for is your pension which is not inflation adjusted.

Even if your math is exactly right you are planning almost 50 years into the future and if you look back at recent history there has never been a 50 year period that did not have a lot of unpredictable events. For an individual it is even harder to predict for 50 years since a personal event could completely change your plans.

Being a bit more conservative because your are doing well is one thing but you are not anywhere the to the point where you can go to an ultra-conservative asset allocation since you are still depending on future wage earnings in addition to your future investment earnings.

Since you have pensions and social security you also need to run the numbers three ways since if either of you dies the pensions and social security could be reduced.
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Re: How much risk do I NEED to take?

Post by bobcat2 »

bobcat2 wrote:I think your analysis would be simpler and more accurate if you did everything in real terms instead of nominal. If you do that the only adjustment you have to make when considering different inflation scenarios is to deflate the nominal pension by the inflation rate. The way you are doing it requires inflating everything but the pension by the inflation rate.

BobK

Let me say this another way. Do all your analysis in today's dollars (real terms). If you do everything in today's dollars, then instead of having to inflate everything but your pension, all you need to do is deflate your pension by the inflation rate. It is much easier to see where you stand in the future if you use today's dollars in your analysis.

Seeing if you can delay your pension is worthwhile, but what is more important is delaying SS. If you delay SS until age 70 your SS benefit will be approximately 25% higher for the rest of your life and your wife's life - whoever lives the longest. Between ages 67 and 70 you can take the amount of income you would have got out of SS from withdrawals from your portfolio. You should also consider different SS strategies for your wife such as when to take, spousal benefit vs her benefit, and perhaps spousal benefit at full retirement age and then switching to her own delayed benefit at a later age.

SS says benefits will be cut 25% if absolutely nothing is done to fix SS and benefits are cut across the board to make it sustainable for the next 100 years thru the current payroll tax. So that is a worst case scenario. Nothing wrong with looking at a worst case, but I wouldn't make that my base case. A base case of a 10% reduction is conservative and realistic.

If you are really worried about high inflation during your retirement you should be investing in inflation-indexed financial assets. Namely you should be delaying SS benefits until age 70, and purchasing TIPS bonds laddered to mature in different retirement years, I-bonds, and inflation-indexed life annuities (SPIAs). You can purchase inflation-indexed life annuities thru Vanguard.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Ok, I re-calculated using today's dollars, and just deflating the pension.

Income need (in todays' dollars)= $60,000; SS (from latest statement --- $2,533/month) =$30,396; Pension (from latest statement, deflated by 3%) = $30,195 Total income = $61,311. There is no shortfall.

I'm scratching my head here. Why doesn't work out the same mathematically?
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Re: How much risk do I NEED to take?

Post by Sandman62 »

bobcat2 wrote:SS says benefits will be cut 25% if absolutely nothing is done to fix SS and benefits are cut across the board to make it sustainable for the next 100 years thru the current payroll tax. So that is a worst case scenario. Nothing wrong with looking at a worst case, but I wouldn't make that my base case. A base case of a 10% reduction is conservative and realistic.
But that doesn't necessarily mean that each person's SS will decrease by 25%, right? If the government decides to means-adjust, some will lose [a lot?] more, and some less [or none at all]. :annoyed
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Re: How much risk do I NEED to take?

Post by redhounds »

RandyAdams1978 wrote:Ok, I re-calculated using today's dollars, and just deflating the pension.

Income need (in todays' dollars)= $60,000; SS (from latest statement --- $2,533/month) =$30,396; Pension (from latest statement, deflated by 3%) = $30,195 Total income = $61,311. There is no shortfall.

I'm scratching my head here. Why doesn't work out the same mathematically?
I'm confused on how you got the pension number. How many years until you can start taking it and are your numbers above in today's dollars or future dollars? If it's $31,872 per year, what calculation are you using to deflate it by 3% that ends up with $30,195?
--Red
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Red
I 'm not sure what I did there. I fat fingered something. All figures are in today's dollars. I was attempting to deflate the pension as opposed to inflating the other values. Should be $29484. $30396*.97. I was trying to account for 3% inflation. But... do I need to do that 14 times since retirement is 14 years away?
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RandyAdams1978
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Re: How much risk do I NEED to take?

Post by RandyAdams1978 »

Let's try this again

All in today's dollars. Retirement is 14 years away.

Income need = $60,000
SS (from last statement) = $2,533/month, which equals $30,396 per year
Pension (from last statement = $2,656/month = $31,872 per year.

Bobcat suggested I deflate the pension, rather than inflate the other values. If I deflate the pension to account for 3% inflation, then I get (31,872 * .97) = 30,916. But that's just one year's worth of deflating. Do I need to do that 14 times? If I do that 14 times, it comes down to $21,451. That leaves me with about a 8-9K shortfall in year one of retirement.

Is THAT how I should be figuring it?
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Re: How much risk do I NEED to take?

Post by The Wizard »

Yes, 0.97^14 = 0.65 is what you need.
But in all honesty, 14 years is a bit far ahead to get too specific.
I'd just save/invest heavily over the next 5 years or more and revisit this once you get within 5 years of retirement.
Once you get within five years, you'll have a more confident handle on all your numbers...
Attempted new signature...
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Re: How much risk do I NEED to take?

Post by redhounds »

The Wizard wrote:Yes, 0.97^14 = 0.65 is what you need.
But in all honesty, 14 years is a bit far ahead to get too specific.
I'd just save/invest heavily over the next 5 years or more and revisit this once you get within 5 years of retirement.
Once you get within five years, you'll have a more confident handle on all your numbers...
This (the deflated number ends up being roughly $21,000). And I agree that it is a little too early to get too specific on the numbers.
Last edited by redhounds on Tue Sep 24, 2013 7:42 am, edited 1 time in total.
--Red
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Re: How much risk do I NEED to take?

Post by redhounds »

oops.
Last edited by redhounds on Tue Sep 24, 2013 7:42 am, edited 1 time in total.
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Re: How much risk do I NEED to take?

Post by HomerJ »

RandyAdams1978 wrote:Let's try this again

All in today's dollars. Retirement is 14 years away.

Income need = $60,000
SS (from last statement) = $2,533/month, which equals $30,396 per year
Pension (from last statement = $2,656/month = $31,872 per year.

Bobcat suggested I deflate the pension, rather than inflate the other values. If I deflate the pension to account for 3% inflation, then I get (31,872 * .97) = 30,916. But that's just one year's worth of deflating. Do I need to do that 14 times? If I do that 14 times, it comes down to $21,451. That leaves me with about a 8-9K shortfall in year one of retirement.

Is THAT how I should be figuring it?
Yes, that number is more correct... You should only need $10k a year in 14 years... so you only need about $250k saved in 14 years... It would be nice to have $500k saved, for a 10k a year buffer. Since you already have $400k saved and 14 years for that to grow, you are doing great and should be fine. No need to take a lot of risk.
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