#38 My #1 Retirement Planning Tool to Help People Find Balance [Podcast]

I'm convinced that the most stressful part of planning for and living in retirement is that we don't know how to balance living well today while not sacrificing tomorrow. As a result, most of us live out of balance. Some of us are so worried about tomorrow that we sacrifice our current lives in order to be "prudent." Others "live for the day" without a thought for their future. Both are wrong. In this episode, I talk about my #1 retirement planning tool to help others find this delicate balance.

Christmas Present Idea I mentioned.

Here is the link to Fracture Me I mentioned. They'll put any photo on glass. I'll do a separate post showing the one I bought. If you want to save $5 on your first order (and reward me some) you can use this reference code: RFR54483. If you order one, look for the small pamphlet to get a referral code you can share, too.

Invest Wisely--Investing Potholes in November and December

If you're planning on making large investments in your taxable accounts, be careful.

In December, most pooled investments like mutual funds distribute to shareholders the capital gains and dividends they've accumulated throughout the year. If you buy one of these products in a taxable account before this distribution, you could have a tax liability for capital gains that were realized before you even own the fund.

In this episode, I discuss how this works and some things you can do to avoid a potential nasty tax surprise.

Plan Well--My #1 Retirement Planning Tool to Help People Find Balance

Can I afford to retire a year earlier?
Do I need to change my spending plan after this market correction?
Can I save less now and still retire comfortably?
Do I need to take so much investment risk?

These are some of the frustrating questions that people struggle with every day as they plan for retirement. About 16 years ago, I discovered a tool to help me help people answer these questions and confidently live a more balanced life. It's called Monte Carlo Engine.

Today, I've integrated it into my Plan Well process to help others make smarter financial decisions and find some balance between living well today without sacrificing their tomorrow.

Like most tools, some are better than others and much of its usefulness is dependent upon the skill of the user.

In this episode, I use a planning example to demonstrate how I use it and some of its advantages and drawbacks.

Note: Normally if you just read these show notes, it's best to listen to this one. Just click on the audio play at the bottom of this post.

Here is the Fact Set for John Smith

Age 55
Retirement goal 60
Investment assets $2,000,000
Retirement lifestyle goal, $100,000 annual
Retirement lifestyle goal #2, $70,000 RV at age 60
Life expectancy, age 90
Target Portfolio, balanced II

To see the full report that I discuss, click here.

How Not to Use It

It's not a one time evaluation tool (you can't set it and forget it)
It does not determine or predict results
It can't overcome bad inputs or assumptions

How to Use It

As an important part of your annual financial review
As a tool to help you prioritize competing goals
As a tool to help you evaluate tradeoffs between competing priorities
- Spending/Saving
- Working/Retiring
- Risk/Reward
- College/Retirement
- Giving/Investing
As a compass to help evaluate and correct course as your life unfolds
As a guide and warning system to help you know when your plan may be unsustainable
To provide more color on the long-term impact of today's financial choices

There is no tool that will solve for all the uncertainty in your life or the world.

The best we can do is acknowledge what we don't know (can't know) and use a sound compass to help guide our life's journey.

"He, who is enslaved to his compass, will enjoy the freedom of the seas."
Ken Davis

Are You Confident in Your Compass?

The Retirement Answer Man Episode #38

Well, hi there! This is Roger Whitney. I am the Retirement Answer Man and this is the show dedicated to helping you find that balance between living well today without sacrificing your tomorrow.

And, to help you on that journey this week, in our Invest Wisely segment, I’m going to point out a couple of potholes that come up in November and December each year for those of you that are looking to make investments in taxable accounts – these are tax potholes that you definitely want to avoid.

And then, I’m going to spend most of our time in our Plan Well segment and I’m going to unwrap a planning tool I couldn’t do without. Well, I could probably do without it, but it provides so much color in helping clients make wise decisions as they plan for and manage their retirement that I want to unwrap this and I’m going to try to do it without getting into Geekville very much. I’ll keep it high level but I think it’s important if you’re planning because you may come across this tool or your advisor may use this tool and it’s important to understand how it works and what it can and cannot do.

But, before we do that, since it’s after Halloween, it’s officially the Christmas or holiday season, I want to give you my Christmas gift tip of the week. I was listening to the Mac Power Users podcast – which, if you’re a Macintosh or Apple geek, you like shows like that – and they have a new sponsor called Fracture Me – fractureme.com – and what they do is they will take any photograph and put it onto glass and it’s a really unique way to display some of your favorite photos.

So, what I did, being the geek that I am, I ordered a 23-inch by 23-inch fracture of my podcast artwork and it looks really cool. I already have it up in my office. I’ll post a picture of it in the show notes. I’ve decided that, for all of the people that I love, I’m going to give this to them for Christmas. Now, I ‘m not going to give them my podcast artwork – that would be just…. I don’t know what that would be.

What I’m going to do is I’m going to try to get photos of family pets or their family or something that they care a lot about and I’m going to create this fracture glass photograph so they can display it in a unique way and I think it does two really good things – one, it’s really cool, cutting-edge, and I always like that type of thing, but when it comes to Christmas, this is really personal. I know with my mother-in-law, she has a dog now and she’s had wonderful dogs throughout her life that have lived and passed away and I’m going to try to grab photographs of some of those dogs so she can have those on her wall. That’s cool, I think. That’s a personal gift and those are always the best kind of gifts. So, I’ll have the website – fractureme.com – on the show notes. I don’t have any affiliation to them; I just think it’s really cool.

So, you can find me on the internet at rogerwhitney.com – that’s the home of the Retirement Answer Man and that’s also the home of the Retirement Answer Library. This last week, I’ve set a record – we’ve set a record – of the most registrations to the Retirement Answer Library and I think that’s so cool because that means people are taking control and wanting to plan well and invest wisely in their life and I think that’s just awesome.

In the Retirement Answer Library, there’s now over 22 checklists and a few videos to help you make smarter financial decisions in your life and the cool thing is it’s totally free. I curate all this content and I create a little bit of it of things that I find and use in my own practice so you can plan well in your life. So, just go to rogerwhitney.com and you can register for free for the Retirement Answer Library.

All right. Well, it’s time for the all-important disclosure, and that is – now, don’t fast-forward me because this is important here – only you know your entire financial situation. Consider this podcast, my blog, really anything you read or hear on the internet as helpful hints and education because we don’t know a thing about you. Talk to the people that do before you make any decisions; that could be your legal advisor, your tax advisor, or your financial advisor. And that’s just not great legal advice, that’s a fundamental principle of planning well financially.

All right. Well, in our Invest Wisely segment, I want to talk a little bit about pooled investments like mutual funds and things like that. Basically, what you buy when you buy one of these pooled investments is a portfolio of stuff, right? It could be stocks, it could be bonds, it could be real estate, and you just see one item on your investment statement. Well, throughout the year, all those individual investments that that mutual fund or pooled investment owns, they pay dividends and the investment manager will buy and sell things so they’ll accumulate dividends and capital gains from trading the portfolio throughout the year but they don’t issue those capital gains and dividends to you until the end of the year and that’s where you pay taxes on your portion on those items.

Typically, they’ll pay those out in November or December so what can happen – and this is the pothole that you need to be aware of – is, if you’re investing in a taxable account in November or December and let’s say you buy mutual fund A on December 1st, well, if they issue all the capital gains in dividends that they’ve accumulated on December 2nd for tax purposes, what will end up happening is, after one day or ownership, you’ll have a tax liability for your portion of all those capital gains and dividends that happened throughout the year when you’ve only owned it one day! Now, that could be inconsequential or it could be a huge tax issue, depending on the dollars and the investments involved. So, it’s something that you want to be aware of if you’re investing in a taxable account in November and December especially.

So, what do you do about it? Well, you can talk to your financial advisor before you make any investments and have them check what the expected distributions will be because most companies will issue what they’re expecting to issue in terms of capital gains and dividend tax consequences and they’ll usually tell you a date that they’re probably going to do it. I’ve seen some of those expected distribution reports come out already so you can talk to your financial advisor and make sure that they check that for you – that should be part of their job – or you can, if you don’t have a financial advisor, you can go directly to the website of whatever vehicle you’re looking at purchasing and see if they’ve issued what their expected distributions are going to be and when it’s going to be and, if it’s not there, then maybe you look at what they did last year and you get a sense for how they do it.

This can help you decide whether you need to totally avoid that tax pothole because it’s too big or evaluate that it’s really not that big and I can drive right through it and go ahead and make the investment anyway, but that’s something that comes up here towards the end of the year.

Okay. Now, let’s move on to our Plan Well segment.

I’m going to talk about a tool, it’s a statistical tool. I’m not going to talk statistics, okay? I’m going to try to stay out of Geekville although I’m a little bit of a geek when it comes to this tool. It’s something called Stochastic Modeling. Wait! Don’t run away! That’s the only statistical term – maybe – of a few that I’ll use. It’s more commonly known as Monte Carlo simulations. So, that brings us a fancy picture in our head of the Retirement Answer Man in a tux with a martini in his hand, but we’re not going to gamble. It’s not about the markets being a gambling place.

Monte Carlo scenarios are a statistical tool to help forecast possible outcomes. I’ve used them for over a decade and I’ve found, in the right hands, they can become extremely valuable in finding that balance between living well today without sacrificing our tomorrow. From a financial perspective, that’s what it comes down to with a lot financial decisions.

If you think of a teeter-totter and, on one end, you want to live as well today as you can; on the other end, you have tomorrow that you want to make sure you live well then as well, right? Complex sentence but that works. And, if you live too well today, that teeter-totter, that balance is out of whack, you may be sacrificing your tomorrow. Or, if you live too much on rice and beans today because you’re worried about tomorrow, that teeter-totter is way out of whack to the future. So, when we make financial decisions, especially as we’re preparing for and managing retirement, we want to find that balance between maximizing our current life without sacrificing our potential future life. So, that’s a teeter-totter that we’re always trying to find the balance to and that’s what my practice is dedicated to. That’s what this podcast is dedicated to!

Monte Carlo scenario can really help you do that. So, rather than give you all the explanations of how it works, what I thought I would do is walk you through an example and then I’ll have this full Monte Carlo scenario example available for download on the show notes so you can see some of the workings behind it, but it’s a really valuable tool when you’re planning for or living in retirement.

So, here’s the example I want to map out for you and I’ll have this on the show notes. If you’re driving, don’t try to write all this stuff down. Just try to stay with me as I walk through this example.

Let’s say I’m sitting at my office, I’m working away, I’m writing a blog or I’m serving a client and I have a gentleman walk in and his name is John Smith. John wants to retire. We outline with John what that means to him. In this very simple example, John says he’s age 55 so that’s the beginning of the input into a tool like this. Age 55 and we’ll assume that John is going to live to a ripe old age of 90 so he has a very long time horizon from age 55 to 90 so that’s a 35-year time horizon. When he turns 60, he says, he wants to retire. At retirement at age 60 – five years from now – he wants to have a lifestyle budget of $100,000 per year. So, if you think of this as a timeline, each year after age 60, he’ll be taking out $100,000 from whatever assets he’s accumulated.

Are you with me so far? He’s age 55. At age 60, he wants to retire and then he wants to start taking out $100,000 a year until he passes away at age 90. This is a typical scenario you might see. In addition, when he’s age 60, he has a one-time purchase that he wants to make of $70,000 for an RV. I hear this all the time; “I want to buy an RV and I want to travel the country.” My wife has this dream! I sort of do, but I don’t know if I want to buy an RV. I’ve already bought an RV trailer, if you recall, and that didn’t work out too well.

Anyway, John wants to buy a one-time purchase of an RV at $70,000 so that’s a cash flow that we can plan for in five years. And then, he’s 55 and I said, “Okay, John, you’ve mapped out what you want to do in five years and what your lifestyle needs to be until age 90. How much money have you accumulated today in investment assets or productive assets?” and says he has $2 million. Okay, he’s done very well. He’s developed an nest egg.

Now, we’ve really developed a cash flow timeline for John. He has $2 million. In five years, he needs to start drawing $100,000 a year from his assets, plus that RV, and he needs to do that until he’s 90 so that’s basically a cash flow timeline that we’ve just developed. And then, I talk to John. I go, “Well, John, what about inflation? That $100,000 that you need at age 60, when you’re age 70, that’s going to be a lot more so we need to make sure we factor inflation to be prudent so we don’t sacrifice tomorrow or be lop-sided on our teeter-totter without even realizing it.” So, we factor in inflation.

The target I use for inflation, and it may seem high to some people, is 4.22 percent and that’s just the average inflation since 1970 – I think it’s ’70 or ’71, I can’t remember. To some, that seems really high; to some, that seems really low. I think it’s the average. We’ll just go with that because we don’t know what the future holds. So, we factor in inflation so that means every year that $100,000 that John will be taking out at age 60 will actually go up by about 4 percent – a little over 4 percent – every single year.

And then, we also have to factor in taxes which is something that Monte Carlo scenario can do. So, what have we just done? We’ve just created a timeline of what John’s life is from a spending perspective. Now, he’ll talk about it in terms of the dreams of traveling the road, living, maintaining his lifestyle and his home during retirement and his gifting and whatever soft things or goals that you and I talk about, but the way I just outlined it creates it into a financial goal that we can start to work on to see what’s doable and what’s not.

The nice thing about these Monte Carlo simulations is that you can factor in a lot of different things. You can factor in employment income, part-time employment income, pensions, and social security to help support this lifestyle. In this simple example, I’m just going to use that John has $2 million and he wants to spend $100,000 a year plus buy an RV just to keep it simple.

So, assuming that we modeled John’s life this way over those 35 years, he’s going to have to do something with that $2 million to help support this lifestyle. Generally, you’re going to invest it in something. So, if we assume John spends exactly like we’ve targeted or outlined here, the only variable in his life would be a portfolio and we sure know how variable investing can be, right? It can be crazy good or really, really bad. And we’re dealing with 35 years so how do we model that?

Well, what we would do is take a model portfolio – say a balanced portfolio of stocks and bonds – and we won’t know what that portfolio will do in the future but we do know how volatile it can be going up and down and we know the type of returns a portfolio like that has had in the past. To be geeky, we know the statistical characteristics of it and we can incorporate that into a Monte Carlo simulation. So, we would take John’s spending plan like we’ve just outlined very simply and we would use the Monte Carlo scenario to simulate thousands of different lifetimes for John with that exact spending plan that we’ve outlined and the only variable would be his investment portfolio and the fact that it could be really, really good, it could be really, really bad based on the statistical characteristics of the plan. And what you get from all of those iterations or all those thousands of simulated lifetimes for John is you get a percentage of the time that he’s able to achieve all those goals because the portfolio did reasonably well. And then, you’ll get a certain percentage where the portfolio modeled the worst markets that we’ve ever seen and he ran out of money early. Well, that would not be good, right?

By simulating all these possible market experiences for this outlined cash flow for John, we’ve developed some color as to what’s possible and what’s not. So, what kind of results do you get from all of these different types of iterations? Well, let me give you an example, and this will be on the report that’s available for download on my website, and I’ll give that to you here at the end of the podcast so you can get that. Well, in some scenarios, John died. His $2 million grew to $61 million! Well, we know that’s not going to happen. I mean, it could statistically, but that ain’t going to happen. But, on the flipside, we had John running out of money right around year 25. He died broke. Well, even worse; he was alive and broke! So, you have this huge disparity, but somewhere in the middle, by running so many scenarios, you get to what’s probable or expected anyway, and we’ll get into some of the nuances of that. So, by doing all these iterations for this scenario with John, what we found was 84 percent of the simulated lifetimes or trials, they achieved all of the spending goals that John outlined that we outlined for John. So, 84 percent of the time, he was able to maintain that spending, he was able to buy his RV, and he died with money. He didn’t die broke. We’ll call that an 84 percent confidence level that he could achieve all these spending goals, assuming he spent it exactly like we outlined and we invested prudently and consistently in a portfolio that we modeled. That gives us some comfort level that, “Hey, John, you could do this.”

Well, what about that other 16 percent? Why isn’t this 100 percent of the time it worked? Well, 16 percent of the time, he fell short and he actually ran out of money before he died in this Monte Carlo scenario. So, the common question is, when you start to talk to people like this, well, if 84 percent confidence level in trials is good, wouldn’t 100 percent be great? And you would think that it would be great, right? Well, we could probably get the simulations to work out to where 100 percent of the time we could tell John, “You could achieve this – theoretically.” But what’s the problem with that? Think of your teeter-totter again, right? Think of the teeter-totter of balancing today and tomorrow. If we tried to get John’s trials to equal success 100 percent of the time, we could do it but, more than likely, we’d have John working longer or spending less or not buying the RV or investing more aggressively – any one of those levers would allow us to sacrifice his current life for the perceived value of $100,000 confidence in the trials. But then, your teeter-totter is going to be way out of whack. It’s going to be way focused on taking care of a potential tomorrow at the price of sacrificing the only life that John has.

What about the other scenario? Well, what if 84 percent confidence is a great spot, what about 70 percent confidence level? What if 70 percent of these potential lifetimes using a modeling system like this, well, wouldn’t that be good enough? We could indeed get it to a 70 percent confidence level by having him spend more or retiring earlier or taking less risk and we could do that and, to be blunt with you, that might be possible, this is much more of the art part of retirement planning than it is science. There is no rule that says 70 percent confidence is better than or as good as an 85 percent confidence level. But what I would argue is that that may be tilting that teeter-totter way too much to today with potentially sacrificing the future and you won’t find out until the end.

In my practice, I try to target an initial confidence level using a Monte Carlo scenario tool of around 85 percent of the trials actually working and then I usually have a comfort level between 90 and 75 percent as I re-run these over time, and those end up being my warning lights on the high end of 90 percent or the low end of “Hey, we need to make some changes here.”

If you’re John and you’re looking at spending like this and you want to buy that RV, it’s hard to have a framework to know whether you can do it or not because you don’t know how this is going to affect your like twenty, thirty years from now. So, Monte Carlo scenarios are a great tool to help provide more color to that discussion. It doesn’t mean it’s going to happen just because the tool says it’s possible in its statistical model. It’s still very inadequate because, you know, it’s all about the future. We don’t know what’s going to happen there. But it brings more color and framework to John to be able to decide where that balance is in his teeter-totter so he can maximize his entire life – not just today and not just a potential tomorrow. That’s why this is such a great tool to use in a retirement practice because it brings some of that color discussion.

Now, let’s talk about how not to use this tool because, as good tool as this can be, there are some that are built inadequately and I’m a little bit of a Monte Carlo snob because I’ve used it for over a decade that there are some statistical models like this that I just don’t like. I don’t like the way they’re built – the assumptions they have baked into them. So, you can have a good hammer or a really bad hammer. I think I use a really good hammer that’s well-constructed. But how do you use the tool?

Even if you have a really good hammer, if you have it in a very untrained hand, what’s going to happen? You know, you give Roger Whitney, the Retirement Answer Man, a hammer, yeah, I can build you a table but it’s really not going to be one you want to put anything precious on because it’s probably going to collapse. You can give me the best hammer in the world, I’ll make the same table that I would if I had a really bad hammer because I don’t know what the heck I’m doing when it comes to carpentry.

The tool is only as good as the practitioner. What are some of the ways you don’t want to use this? Well, one is you don’t want to use a Monte Carlo scenario like this for one-time evaluations. So, if John just came in in the scenario that I outlined and had somebody or he found an online tool and he ran this scenario and goes, “Yeah! I’m 84 percent, I’m good!” and then John just marched off and never looked at it again, that’s a recipe for disaster because, just like a business plan, this is all about the future and the future is fundamentally unknowable.

The Monte Carlo scenario is only a compass. If you were to do a trek across the continental divide, you wouldn’t look at your compass once and just start marching and never check it again because the terrain changes, your pace changes, the wind changes, the weather changes, your health changes. You have to constantly use it so you don’t want to use this as a one-time evaluation tool.

The second way you don’t want to use it is you don’t want to think about it as predicting success in the future. This tool has absolutely zero ability to predict success of anything. It’s just a compass. It’s a really, really well-made sophisticated compass, but it’s just a compass. Just because, in the scenario that we outlined here, John has an 84 percent confidence level, that really doesn’t mean diddly squat for the long term. It doesn’t mean that he will be successful. It just means, “Hey, John, you’re on a good path right now.” You don’t want to use it and fool yourself to saying, “Well, I read it,” or, “I was told that it would be a success,” because it doesn’t work that way.

Lastly, and the most obvious way, you don’t want to work with anybody that uses it like a sales tool, and this could easily be used like a sales tool. I would almost say that, if it feels like a sales tool, it’s probably in an unskilled hand.

So, how do you use it? I’m going to give you a couple of ways that you can really incorporate the sophisticated compass to help find that balance in your life. Probably the most impactful – and this is how I try to implement it with the clients that I work with – is you use it dynamically in all the little conversations you have about financial matters.

In John’s case, as an example, you set that target. You make sure that this is the life he really wants to lead and then, as his life unfolds and you have systematic little conversations, you constantly recheck all the assumptions and re-run everything because what will happen is John will never spend like we’ve outlined. It never works that way. He’ll spend more for a while. He’ll spend less for a while. He’ll buy a bigger RV. He’ll decide that he wants a house rather than an RV. As his life unfolds, all his priorities will unfold and you want to adjust along with that and that’s what a compass like this can do. It will help you recalibrate that balance on that teeter-totter based on what is actually happening and what desires you have. You want to use it dynamically and recheck it and recheck it because it will help you find that balance if you use it correctly.

Another way you can use it – and this would be the case in the example that we used – what if you have this big expense that’s coming up or a dream or a desire that has popped into your consciousness that you and your spouse have decided you wanted? You know what? We really decided we want to do an around-the-world trip while we’re healthy and it’s going to cost $40,000 – I don’t know what they cost so we’ll call it $40,000. How do you make that decision?

If you’re retired and you have this sudden desire that is true and pure, that you want to travel the world for $40,000, this type of compass – the Monte Carlo scenario – can help you, help frame for you whether by doing so you’re tilting too much to living too well today and you’re actually going to sacrifice your tomorrow or it can give you the comfort that, “Wait a second. I can afford to spend this money and know that I can do it and I’m not sacrificing tomorrow based on a skilled hand looking at the best compass available.” It can give you that comfort level that you’re not sacrificing your tomorrow or it can say, “No, you really are.”

It will give you that framework to make a more wise decision in your life and I think that’s really powerful. It can also help evaluate if you work part-time. Maybe that will allow you to take less risk in your portfolio or retire a year early. All these different things can come into play if you have a sophisticated compass like this and you can use it in a skilled way. That’s one reason why I find this one of the most valuable tools in my toolbox, and it’s not because of what it does in a one-time scenario. It’s what you can do with it if you understand how to incorporate it in all those little conversations.

I wanted to unwrap Monte Carlo scenario as you work towards retirement and live in retirement and how it can be powerful in your life because a lot of financial advisors use them so you’ll more than likely come around them so you can understand a little bit about how they work and then you can look out for some of the unskilled ways of using it and some of the more skilled ways of using it. And then, if you have availability to this tool on your own, hopefully this will give you a good basis to be able to incorporate it in your own planning.

Now, I’m going to have available on the show notes the download of this example of John Smith showing the entire Monte Carlo scenario and plan and success ratio. I encourage you to email me directly or go to my website and go to You Ask, I ANSWER if you have any questions about Monte Carlo scenarios as a tool – whether it’s deep down into the Geekville or more on the wisdom level of how you can use it. I encourage you to engage with me and I’ll answer your questions the best that I can as to what they can do and my opinion of how you use them. I’ve used them for – wow – about sixteen years now so I’m very familiar with a lot of the programs out there.

I’ll have that for download in the show notes. Just go to rogerwhitney.com/38 and you can download that report and always feel free to ask me questions on probably one of the most important tools of my planning practice.

Well, I want to thank you so much for joining me today. I hope this has helped you learn to plan well and invest wisely in your life.

My name is Roger Whitney and, until next week, be well.