Most people mentally picture getting to, and then through, retirement as a straightforward and linear path. Of course, that is desirable. But is this a realistic expectation?
Some advisers may suggest the top path is possible by emphasizing “safety first.” This comes from Social Security and/or a pension (if you have one like your grandparents had). It is also possible via purchase of an immediate annuity. However, these annuities are fixed income tools (unless you purchase one with inflation adjustments – which provide less income relative to non-adjusted annuities) which means inflation erodes the purchasing power how much you can buy with your money over time. Thus, the mental upward sloping desire we have in the upper panel above is, in reality, downward sloping due to this loss of purchasing power (inflation).
The markets lead people to picture the lower panel. Retirement is not that much different than working years. During working years, your job depends on the economy. If the economy suffers, the business you work for may also struggle and have to cut workers, pay or both (recall 2007, 2008 and 2009). When times are good, pay raises and promotions tend to be the norm since employers compete for their labor and need to make attractive offers to keep workers. Thus, working years when one thinks about it, are not that much different from the bottom panel pictured above.
Retirement expectations once retired shouldn’t be any different really from our working years. Sustainable retirement income also depends on the health of the economy. Many suggest using annuities to avoid that. However, insurance companies also invest in the same markets so how can they avoid uncertain markets and economies? They don’t! Insurance companies attempt to have reserves to buffer the bumps. But, should everyone migrate into products of insurance companies, then the law of large numbers would put stress on those reserves during hard times and the products too would fail eventually.
This collapse of expectations is worse, in my humble opinion, than building a plan based on realistic expectations – albeit with some variance in values and spending. You see, the heights of the highs, and the depths of the lows, may be buffered by prudent design of the portfolio allocation. This approach is based on embracing uncertainty, both in market values (we can’t avoid the effect of the global economy on us – we’d have to go to some other globe to do that) and in the uncertainty of our longevity. We have always lived with uncertainty; many choose to ignore or forget this.
Social Security provides a base income. Pensions, if you have one, provide a larger base. Prudent design of your remaining income caps your retirement plan.