Retirement advisors must hate me. They call regularly, but they’re never hired.
Ever since I retired in 2008, I’ve been executing my own plan for the future. I don’t need to hire experts because my approach is so simple, so boring, and so reliable that I can easily handle everything myself.
Best of all, my retirement plan is powered by something that’s largely within my control (household spending) rather than by something that’s beyond my control entirely (stock market returns).
If stocks were powering my retirement, I wouldn’t always sleep so well. But through any market turmoil I snooze away just fine.
To implement my simple, boring, and reliable retirement plan you need to know only three numbers:
(1) your age;
(2) your annual household spending; and
(3) your net worth.
Like I said, it’s a simple plan. Here’s an example:
(1) John Dough is 50 years old and so is his wife Jane;
(2) their “burn rate”—annual household spending—averages $40,000 per year; and
(3) their net worth is $2 million.
Are the Doughs in solid enough shape to retire at age 50?
Yes, they are.
How do I know?
Because their net worth is enough to cover 100 percent of their spending needs for the next 50 years. The math is so easy a third grader could do it: $2,000,000 net worth / $40,000 burn rate = 50 years.
But how can I know whether 50 years worth of spending will be enough?
Statistics. According to the US Census Bureau, only 0.02 percent of citizens live to see their 100th birthday—that’s 1 in every 5,000 persons. Thus, as long as the Doughs’ adapt reasonably to inflation (more on this below) the odds are very high that their money will outlast their lives.
THE WASTING ASSET RETIREMENT MODEL (WARM)
My simple approach to retirement treats a nest egg like a “wasting asset.”
A wasting asset is an asset that has a limited lifespan and thus loses value over time. Eventually, the asset’s worth drops to zero (or slightly above zero if the item has scrap value).
Your refrigerator is an example of a wasting asset. You buy it new for $1,000 or so. After that its resell value declines steadily until it stops working—whereupon you haul it to the junkyard.
Our nest eggs can be treated like wasting assets because we ourselves are wasting assets. Inevitably, human bodies decline just like refrigerators do (our remains might avoid the junkyard, but not the bone yard). When we depart, our wealth is worth nothing to us because we can’t possibly access the money—and of course we’re too dead to care.
The WARM method for retirement planning can be presented as a simple chart (see below). If you know your annual burn rate and the years you’ll be retired, the chart shows how big a nest egg you need. If you know your annual burn rate and net worth, the chart shows how long your money will last if you treat it like a wasting asset.
Wasting Asset Retirement Models
|Annual Burn Rates of $20k-$100k and Retirements of 35-65 Years|
You’ll notice this chart says nothing about investment returns. That’s because WARM distinguishes between: (1) your accumulative years, when you buy stocks to grow wealth; and (2) your post-accumulative years, when you avoid stocks to preserve wealth. Once your nest egg grows large enough to fund your desired term of retirement (see chart above), you transition your portfolio to safer assets.
In our household, for example, our nest egg has grown large enough to last us both past age 100 as long as we adapt reasonably to inflation (more on this below). Accordingly, we can afford to maintain a conservative asset allocation: 6.51 percent in stocks, 27.94 percent in real estate, and 65.55 percent in money markets/bonds.
Most professional advisors would deride our asset allocation as unduly timid, but our response to them is this: if we already have enough assets to both get past age 100, why should we expose ourselves to unnecessary risk? We’re frugal, not materialistic. We harbor no ambitions to suddenly become big spenders. Any gains we achieved from stocks would be entirely superfluous to our needs—and any big losses might send us scurrying back to the workforce. We therefore follow a retirement plan that avoids market turbulence, which is something we can’t control, and leverages our ability to manage household spending, which is something we do very well.
In other words, with this conservative approach to retirement, we sleep both safe and WARM.
What happens to you if inflation rears its ugly head?
If inflation grows, it won’t happen overnight. We’ll have enough advance warning to cut our discretionary spending. Our current lifestyle reflects many luxuries. Relatively painless cuts of 25 percent or more are well within reach. If absolutely necessary, we can also invest in greater risks that offer the prospect of larger returns.
But then again, if inflation grows we might just stick with our existing plan. Such a response is possible because WARM includes two baked-in hedges against rising prices.
First, WARM ignores the money we’ll receive from social security. Retired workers currently average $16,220 in social security benefits per year—and our household contains two retired workers. By law, social security benefits increase each year in lockstep with the Consumer Price Index. Sure, a glut of baby boomers is straining the system’s finances and this may reduce future benefits. But reduced benefits are not the same as zero benefits. Social security will continue to exist in some form or other. And its steady income stream will offset inflation.
Second, WARM assumes that our annual expenses will remain level until we die. In reality, our spending will drop off long before we do. The Employee Benefit Research Institute reports:
“Household expenses steadily decline with age. With the age 65 expenditure as a benchmark, household expenditure falls by 19 percent by age 75, 34 percent by age 85, and 52 percent by age 95.”
Expenditure Patterns of Older Americans, 2001-2009, S. Banerjee (EBRI Issue Brief, 02/2012). Why the big declines? Simple answer: although oldsters spend more on medical care as they age, they also spend much less on travel and entertainment. Accordingly, inflation in later life is offset by lower living costs.
What about your longevity risk?
We believe we’ve adequately accounted for longevity risk by accumulating enough assets to get us both past age 100. In any event, if future medical advances dramatically extend current lifespans we can always reduce our burn rate and, if absolutely necessary, increase our exposure to stocks.
What about leaving a legacy for the next generation?
We have no children and we don’t believe in dynastic transfers of wealth to our nearest relatives. Our attitudes about inheritance are informed by our experience. People who expect big windfalls tend to coast, thus denying themselves the fulfillment that comes from productive pursuits. So instead of crushing the work ethics of our nieces and nephews, our estate plan funds several deserving charities that we’ve supported for decades. Our legacy will help many people instead of just a few lucky heirs.
By the way, please feel free to disagree with our estate plan. We know it’s not for everyone. But if you want to enrich your relatives, you need to gauge how much portfolio risk to undertake in order to reach that goal. Fair warning: rides in the stock market sometimes get rocky.
What are the tax implications of WARM?
Current federal policies, especially in the setting of interest rates, favor debtors over savers. As a result, our cash holdings haven’t produced much income—each year, we end up in the 10 or 15 percent federal tax bracket. But our low brackets have produced some helpful side benefits. For instance, Obamacare premium tax credits regularly subsidize our health insurance costs. Moreover, the tax code exempts us from paying taxes on capital gains and qualified dividends. For a full list of the many tax benefits we’ve enjoyed in early retirement, click here.
How does WARM compare to the Four Percent Rule?
The Four Percent Rule is a well-known formula for funding retirements that last as long as 30 years, which is the outer reach of traditional financial plans (quit at 65, die at 95). Under this rule, new retirees withdraw 4 percent of their nest egg to fund first year expenses and then in each successive year they adjust that dollar amount upwards for inflation. See New Math for Retirees and the 4% Withdrawal Rate, T. Bernard (New York Times, 05/18/2015).
Importantly for risk avoiders, the Four Percent Rule assumes that the retiree’s portfolio is split evenly between stocks and bonds. In contrast, a WARM retiree’s portfolio can afford to have a much smaller position in stocks (in the case of our household, less than seven percent).
WARM retirees have to pay for their ability to sleep soundly through market gyrations—there’s no such thing as a free lunch. The best way to explore the necessary trade-offs is to review this chart.
4% Withdrawal Rule vs. WARM for a 30 Year Retirement
|Burn Rate||4% Rule Nest Egg||WARM Nest Egg||Percent increase|
As the chart reveals, retirees who follow the Four Percent Rule can convert to a WARM retirement in three different ways.
First, they can switch to WARM by amassing a 20 percent larger nest egg. This means lingering longer in the workforce or extending their exposure to the stock market.
Second, four percenters can reach WARM by cutting expenses. For example, retirees with burn rates of $40,000 need a $1 million nest egg to fund a 30-year retirement under the Four Percent Rule (see chart above). If, however, these retirees reduce their spending to $35,000, a similar-sized nest egg funds a switch to WARM. (Those who enjoy frugal living will likely prefer spending cuts to longer stays in the workforce.)
Third, to reach WARM retirees can combine larger nest eggs with lower burn rates in whatever mix they find most palatable.
* * *
To sum up:
WARM elevates expense management (which you can control) over portfolio performance (which you can’t control). In the process, WARM lowers the risk of outliving your money, removes the need for expert advisors, and cuts income taxes. The price you pay for all this tranquility is: (1) a slightly larger nest egg; (2) a slightly lower burn rate; or (3) a thoughtful mix of each.
So what do you think of WARM? Is it something you would consider or is it too conservative for your tastes?
Please let me know by leaving your heated comments below. 😉
That’s Life photo by WSilver.