Chapter 2: Improving your probability
Michael and Jennifer look at each other before posing the question we know is coming. "What do you mean we have a 25% probability that we can retire now?"
"It's not that you have a 25% probability of being able to retire. You have a 100% probability of being able to retire. That choice is totally yours. Our job is just to ensure that your investment portfolio will provide you with the retirement you want, and it's our job to be honest no matter what. As we run the numbers, it doesn't add up. But don't worry, there's good news coming."
"What is the good news?" Michael asks, with a grin.
Let's just take a step back and review...
Michael was a successful partner in a law firm and had worked his way up to senior management. With that came increased income and improved lifestyle. However, stress was the unwelcome companion and now Michael wanted to walk away, earlier than planned. That's why they were talking to us.
When we ask Michael and Jennifer the key retirement questions, they give us the following answers, summarised below.
|Goal: Retire with confidence||Desired|
|When to start retirement||This year|
|Years in retirement||35|
|Annual spend out of portfolio in retirement (today's $)||$120,000 before super, $92,000 after|
|Estate when retirement concludes (today's $)||$400,000|
|Savings per year until retirement||$0|
|Current amount dedicated to retirement||$1.91m|
|Probability factors used turn out as well as expected or better||75%|
Michael and Jennifer are both 60 so they are looking at five years of higher withdrawals (taking them to age 65), and then 30 years of lower withdrawals (thanks to government superannuation). They both feel 95 is a very generous life expectancy - both sets of parents have passed away, none living past age 86.
All the above looks achievable - and indeed it may be - but we know that the future is uncertain. So, rather than Michael and Jennifer simply crossing their fingers and hoping for the best, we look at the probability that a 60% growth and 40% defensive portfolio can produce the planned withdrawals and leave their two children the estate they're hoping to.
And the answer is... it's unlikely. We calculate the probability at approximately 25%, which is far too low - Michael and Jennifer want at least 75% certainty built into their plans.
That can perhaps be summarised as the bad news, but we prefer to call it the reality. Fortunately, there's a path forward. You see, as much as Michael and Jennifer want a definite lifestyle and to leave an estate, they also have flexibility.
The path forward - flexibility
"You'd like to leave an estate of $400,000, in today's dollars, for your children. Is that set in stone or is there some flexibility there?" we ask Michael and Jennifer.
Michael jumps in, "Yes". But Jennifer looks less sure.
Sensing his wife's uneasiness, Michael says, "Listen honey, we're leaving them the house. That's paid for and worth at least $750,000 now, and it may increase in value."
"True, but I'd like to leave at least $100,000 in the portfolio for each of them, to tide them over until the property settles," Jennifer responds.
Michael turns to us, "I agree with that. But yes, we do have some flexibility with that one."
It turns out that, when we pose the question properly, they have flexibility on most items, which we summarise below:
|Goal: Retire with confidence||Desired||Flexibility|
|When to start retirement||This year||In two years|
|Years in retirement||35||30|
|Annual spend out of portfolio in retirement (today's $)||$120,000 net including super||$100,000 net including super|
|Estate when retirement concludes (today's $)||$400,000||$200,000|
|Savings per year until retirement||$0||$0|
|Current amount dedicated to retirement||$1.91m||$1.91m|
|Probability factors used turn out as well as expected or better||75%||70%|
The path forward - priorities
It is now obvious that certain factors mean a lot more to Michael and Jennifer than others. In order to do our job properly, we really need to understand that.
"Michael and Jennifer, you've done a great job thinking through your flexibility here, but it's clear that some of these items are a higher priority than others. Let's talk about your priorities. Of all your retirement goals, what's the most important factor in making your retirement what you want it to be?"
First and foremost, they have no more money to put into the portfolio. This is everything, so there's no flexibility there. We rank that number one, for this reason.
For the next highest priority, the tone of Michael's voice says it all. Work is a stress. He exclaims, "I feel if I work another two years, I'll live five less." So 'retire now' goes next on the list. And since they can't save if they're retired, we put that factor with it. As they rank their priorities, the order in the diagram below appears:
- Portfolio choice or Investment risk
- Annual spend
- Probability of success
- When to start
- Current amount to invest
This wasn't an easy conversation. As is often the case, husband and wife have different priorities and have never really discussed them. However, putting everything on the table, Michael and Jennifer are very accepting about what the other wants. We're told that some of the most honest conversations partners have, occur in our offices. It's just about asking the right questions.
The good news
And here's the good news for Michael and Jennifer: "Not only can you retire, but you can retire right now, with high confidence your portfolio can provide for you."
The look on Michael's face clearly says, "Thank you!"
Jennifer looks at Michael, genuinely pleased with how happy he is. "But how?" she asks.