OPINION: I tested a retirement scenario while factoring in growth rate, inflation rate and lifespan. The difference in ending net worth between our best- and worst-case scenarios at age 95 is well more than $1 million.
Remember the game of Telephone? Players whisper a secret message down the line from one to the next. When the message reaches the end of the line, it’s repeated aloud to the group. And, without fail, it’s been mangled beyond recognition.
Understanding uncertainty in retirement calculations To better understand uncertainty in retirement calculations, I tested a simple retirement scenario:Factors that dominate retirement projections I wrote a while back on the three unknowns that dominate retirement calculations. Let’s start with those three variables and add a few others.
Inflation While it’s trendy now to fret about inflation, until the past few months it’s been relatively tame for decades. If you look at the historical record for inflation you can spot double-digit inflation in the past, but it’s never lasted long. For our purposes here, let’s use some mainstream numbers from the Social Security Administration: “A man reaching age 65 today can expect to live, on average, until age 84.3.” and “About one out of every four 65-year-olds today will live past age 90, and one out of 10 will live past age 95.”Social Security Most of us will rely on Social Security to some extent, but we all know it’s threatened. The average benefit right now is about $1,335 per person for retired workers.
So while our couple’s best case expenses may be $40,000 a year, let’s say their worst case is another 25%, or $50,000 a year. .wsj-interactive.generic-iframe-embed[name="newretirement"] { height: 445px; margin-bottom: 5px; } .at16units .bleed .wsj-interactive.generic-iframe-embed[name="newretirement"] { height: 445px; } body.at12units .bleed .wsj-interactive.generic-iframe-embed[name="newretirement"] { height: 445px; } body .inline .wsj-interactive.
Worst-case scenario Now let’s introduce our first worst-case scenario. What if inflation runs at 4.0%? We crunch the numbers again. Now the net worth at age 95 is about $568,000 in today’s dollars. The impact of inflation is muted because most of our couple’s cash flow is inflation-adjusted in some form.
Reviewing each year in this final scenario, with all of these worst-case factors compounded, we see that at age 75 — just 15 years after retiring — our unfortunate couple is broke. In analyzing these extremes, we are looking at the envelope of retirement possibilities. Monte Carlo simulation, with output in percentiles, would communicate the interior of that envelope better than I’m attempting here.
A retirement model is a compass, not a map. It can tell you where you’re going, but not if and when you’ll arrive.
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