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A DECADE AGO, a large financial firm ran a clever advertising campaign that showed people going about their everyday lives carrying a bright orange six- or seven-figure sum that represented their number—how much money they needed to retire. It was clever because we humans like to simplify—and sometimes oversimplify—complicated issues. It’s one of our cognitive biases.
I spent almost 40 years in aerospace engineering. I did a lot of detailed engineering analyses, calculating expected performance numbers, which could then be compared to a particular project’s requirements. Government agencies frequently provide guidance on how to perform these analyses and what results are acceptable. Even though this was “rocket science” in the popular sense, the process was—in many ways—straightforward. The physics were well understood and, more important, we had a good grasp of the problems we were trying to solve.
My love of analysis is one of the things that attracted me to financial planning. My engineering expertise seemed like a great fit for doing complex retirement projections. I could even use my background in so-called Monte Carlo analysis. At work, we used Monte Carlo techniques to analyze complex thermal radiation problems, but in finance it’s used to look at how a portfolio might fare in countless market scenarios.
Indeed, I was sufficiently jazzed about financial planning that, several years ago, I purchased sophisticated commercial planning software. I was excited to build a “professional” grade model to assess our retirement readiness and evaluate alternative scenarios. In preparation, my wife and I discussed our vision for retirement. I used that information to build a matrix of scenarios, varying a large number of parameters like inflation, retirement dates, vacation budgets, Social Security claiming strategies and long-term-care options.
Housing in retirement was a key subject. We own our primary home, plus a vacation home at the New Jersey shore that we rent out each summer. I analyzed a variety of scenarios, including keeping both homes and renting out the shore house, keeping both homes and not renting, and selling our primary home and moving to the shore. To look at long-term-care needs, I ran scenarios where we sold all real estate at age 80 and moved into assisted living. To account for variations in portfolio performance, I used Monte Carlo analysis.
Needless to say, this generated a wide array of outcomes, but generally the results looked great. There was a little less margin for error in the fancier lifestyle cases—my term for owning two homes—but it still wasn’t bad. I felt good about our retirement plan.
But when I sat down with my wife to deliver this news, it did not go well. I presented an overly complicated and confusing set of results that muddied the picture. There were myriad charts showing income and spending profiles. I presented Monte Carlo results with 1,000 different portfolio trajectories. The message got so garbled that she ended up in tears. I had so overwhelmed her with data, scenarios and assumptions that she had no idea if we had reached our number or not.
In retrospect, I learned that the idea of a single number is compelling, even if it isn’t realistic. After my initial failure at communicating the results, I tried a different tack. I took a narrative approach. I explained to my wife that we were on track for a comfortable retirement. At some point, we would probably downsize to one home. Where that home would be, and when we’ll downsize, wasn’t certain. It depended to a large degree on our children and grandchildren. The large number of scenarios I looked at indicated we had some time and flexibility to make those decisions. We also should have enough funds to cover quality senior living. We’d continue to review and discuss our plan, I told her. I expect we’ll do that throughout retirement. I also learned that her concerns were less financial and more about staying vital, active and healthy. She trusted me with the numbers and didn’t need to understand every calculation.
What did I learn? By all means calculate your number. But when you think about that number, recognize that it represents the sum of your hopes and wishes for a happy and healthy retirement. With that in mind, try to build a plan that includes some margin of safety, so you have the flexibility to deal with the inevitable—and often unexpected—changes to come.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles were Taking Your Lumps, Quiet Heroism and Think Bigger. Follow Rick on Twitter @RConnor609.
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Ahhh, the NUMBER! When I was 40 (22 years ago) I told my wife “the number” was $4M (Canadian dollars) – I felt confident I could generate a 10% return from that and we’d be fine with $400K pre-tax. A decade later, with much lower interest rates, my number changed to $6M. Every time I got a bonus or cashed in some options or units from my employer, it went direct to savings – we did not expand our lifestyle to consume what was coming in. I felt that if I could in retirement replace the salary income coming into the family coffers with investment income of a similar amount, we’d be fine. I know inflation will erode the value of that income. But my plan did not include ever touching a penny of capital. My investment style – which wasn’t working THAT well – changed when I was in my 50s. No more swinging for the fences – I really focussed on good dividend-paying stocks – lots of utilities, telcos, banks/insurers, pipelines etc. It went well; over the past 5 years my total returns are noticeably above that of the Toronto stock exchange, the relevant benchmark for a Canadian. I retired at 60. I do think setting a target amount of capital needed in order to retire is very useful goal – having that as a focus makes one think harder about how one spends, and invests, pre-retirement.
“If you want to hear god laugh tell him your plans for the future”….unknown.
Apparently one problem you did not address is what does the spouse do when you are gone and are unable to soothe her tears and confusion. This is an almost universal problem because a normal division of labor means one spouse cares about the numbers–and the related risk management problems–and the other does not and worse is repelled by the numbers and the issue in general. They just want their spending and lifestyle unconstrained and to sail along blissfully. When you are gone, your comforting control might well fall to those who comfort for a fee. So a major task for the financial managing spouse is preparing for when they are gone by simplifying the investments, documenting well, and not leaving the discussions to one big data dump.
Yes. Did the Monte Carlo scenario include your death or loss of cognitive skills?
We are extremely lucky to have a close friend who is an independent Financial Planner. She is a former nurse who transitioned to a very successful FP career. She has been one of my major inspirations and influences to learn and share what I know. Should I die first my wife has a knowledgable, empathetic, resource who has the highest integrity. We also have 2 sons who are very smart, one a financial professional. We truly are blessed.
So true Richard!! I teach core financial literacy to families trying to escape the money madness roller coaster cycle…simple is best with a focus on having a safety margin. Thanks for the insightful story!
I find there are simply far too many variables to nail down to simply have a number and pretend that hitting it makes adequate retirement a sure thing. Still, it’s easier to concentrate on one thing when trying to build wealth, so I did distill it down to two numbers. One is the minimum ‘number’ that I want to hit. It seems to be right at the boundary where we have a good chance of sustaining a 40 year retirement. I also have a 2nd number, a stretch goal, that’s about 33% higher than the first number, and allows for virtually all other possible events to work against us without blowing up our retirement. That range is what I work with..