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Friday, August 1, 2014

Risk Tolerance

Posted by Dave on June 10, 2014

Dave is also looking to retire no later than 45, but unlike Tim has no kids and doesn’t want any. Dave is from Ontario and is working towards his CGA certification.

In my post last week, I stated that I hoped to be able to save $500,000 in order to retire. At a 4% withdrawal rate, this level of savings would provide more than enough money to support my wife and I. If I were to adjust the $500,000 for inflation of 2.5%, compounded over the next 10 years, I would be at $640,000 – still much lower than was seen as prudent.

I’m not really sure what the answer, or what the right amount of money to retire would be. Is it $1.5 million? This amount of money would give me more annual spending money than I ever would have spent in any year in my life. I know how much my wife and I spend right now, and if anything, for 10 or 15 years, this amount may decrease.

We are by nature “home-bodies”. We read a lot, have quiet hobbies and other than visiting family and friends, don’t really leave our house all that much. I can’t see our desire to essentially be left alone by everyone much of the time (we are kind of cranky as well) changing. I look forward to days I can spend just walking, either around a golf course or in the city, cooking elaborate meals, and consuming more information.

I realize that I may sound naive, but at age 34, the only reason I can see in upping my amount saved (and therefore my years at work) would be to provide a buffer to disease. If there’s one thing that would significantly alter my wife’s and my plans, it would be a long bout of cancer, a debilitating disease like alzheimer’s or a bad stroke, or any other myriad of issues that could arise as we age (in what we hope is a graceful manner).

The odds are pretty good that at some point either my wife and I will have some sort of issue arise that will incapacitate us either temporarily or permanently. If something hits us during our working life, I am covered by my work for Long Term Disability insurance, and I make enough to cover the vast majority of expenses that we would incur.

After retirement, we could purchase Critical Illness insurance to cover some diseases that we might get, which would provide a lump-sum payment to assist with treatment and healing, or we could assume that something like this would cost say $100,000 and budget for that. Either way, I’m not sure how you budget for these type of unknowns. Do you give up on retiring at 45 in order to have that extra buffer available, or do you retire when you want to, live as healthy as you can and hope it all works out?

I’m fairly risk averse, but I’m also 34, talking about would could happen to me a lifetime from now is kind of silly, but is something that I take into consideration. I’m just not all that sure how much to plan for and to give up for a “what if”scenario that may never materialize.

If you have made it to retirement age, how did you decide on “your number”? Did you take into consideration the risk of critical illness or other health issues?


6 Responses to “Risk Tolerance”
  1. Jacq says:

    EV has a good summary post on Wade Pfau’s research and the non-safety of a 4% SWR assumption:

    If you won’t be changing something you do today like saving more or less this year or next year just because the 4% SWR might be a 2-2.5% SWR, it’s a relative waste of time to think too terribly much about it yet. It might change what you do a decade from now but you might get lucky timing in the market too. But it is hard to shut off “future scenario” brain. :-(

    Long term genetics history in my own family (don’t care about averages in the general population) predicts I’ll either get Alzheimers at about 91 yo or have a sudden heart attack or stroke in high 80′s and prior to that live independently. LTC isn’t modeled in except it is hopefully less than the sale of my house/condo (but hopefully the kids get it instead) and hopefully euthanasia is legal by then.

    I stepped away from a number last year or so and moved to thinking of an income stream of actual cash coming into my bank account from dividends, interest etc. It fluctuates a lot less than “the number” does and fits with how I like to invest into actual businesses or ETF’s for sectors vs a broad index.

  2. Pensions would greatly affect my number and who knows where pensions will be in 20 years? $% rule is a pretty good starting point but it really depends on so many other factors especially ones health. Great article!

    Good Day and Grind On!

  3. Tara says:

    We don’t have a specific amount budgeted for catastrophic illness or long term care, we just aimed for 1.3 million in investments to fund our yearly costs and 1 million in paid for real estate (2 properties) which we could sell in event of need. But only you know what your yearly expenses and needs are. We are also a CF couple living a quiet lifestyle, but I have a lot less confidence in the stock & bond markets than the 4% withdrawal rate seems to imply. I decided I would rather retire at 50 with a bit more margin for error.

  4. greg says:

    I also liked this for a pessimistic view:

    details of the Trinity Study aside, I am within 2 years (much younger) … and the outlook I have found fits with my risk tolerance and personality is this:

    1. I like data-driven goals (i.e. Trinity Study)
    2. I like doing much better than guidelines/default goals
    3. I move to get to the base goal and slowly ease up from there

    Recently as severely-early retirement has approached more quickly than I had ever imagined, I don’t even think much about that. Instead I simply find myself VERY slowly letting up (at a rate less than my withdrawal rate would decrease) and inspect how I feel.

    After establishing such an incredibly-strong “frugality muscle”, I have found that I was in the gym a bit too long. But it still involves no contracts or recurring expenses (car, houses or expensive apartments/leases, etc.).

    I’d encourage you to keep on going for a bit, but to experiment and smell the roses!

  5. deegee says:

    Dave, as I have posted in this blog’s comments before, I split my ER plan into two parts. The first part, the more importnat one, was getting from my planned ER starting age (45 for me) to age ~60 using only my non-retirement investments. After that, my “reinforcements” such as (1) unfettered access to my IRA, (2) my frozen company pension, and (3) Social Security would become available in my 60s.

    To me, this made my withdrawal rate not terribly important because it would be a moving target over the years. Instead, I sought to generate more than enough monthly and quarterly dividend income from my current investments to cover my projected expenses. And the magic “number” I kept an eye on in the years leading up to my ER in late 2008 was the value of my exploding company stock I would cash out when I left the company. That number was $300,000 so when it hit that amount in the middle of 2008 I knew I’d be able to generate my desired income.

    I ran some longer-term retirement plans using Fidelity’s RIP software (I am a Fido client) and it showed my portfolio only growing after its low point at age 59 just before the “reinforcements” kicking in, as I expected. My WR is around 2-2.5% now and will increase slightly by age 59 before dropping after that.

  6. Patricia says:

    Do you think you’d need critical life insurance? If you are retired and with Canada’s healthcare system covering virtually everything health related what income would it be replacing as all your income should be passive at that point and come in regardless of whether you are ill?
    Anyway, calculate your likely annual expenses per year after retirement including premiums for extended health and term life insurance and if you think you need it, critical illness too; note that likely these premiums will go up as you age. As it will be years before you qualify for CPP (which will be small as you won’t be contributing to it for many years) or OAS to be on the safe side don’t factor these into your cash flow. I’m assuming you’ll have no other passive income source like a pension later in life. Multiply the number you get by 25, then add a cushion to cover infrequent expenses like cars or major house repairs (if you own either). That should do it.
    I ‘retired’ two years ago at 55 when I qualified for a reduced work pension, even though I have a mortgage that has another 4 years or so to go – my husband and I are now frugal enough that we could do this comfortably (he even retired two years before me). Ironically, I was immediately offered unsolicited contract work. I charge a ridiculous rate and only take on what interests me. I work a few weeks here and there and but don’t need to. As you will still be young and healthy when you retire if you do run into a rough patch or just want to, you can always pick up temporary or full-time work from time-to-time too.
    In a few years my mortgage will be paid off, I’ll be taking early CPP, and five years later OAS (which you will also get). I’ll probably spend a bit more then and invest the rest – who knows, maybe I’ll need a care home in the far distant future!
    If I’d been paying attention and thinking about it like you smarties are at your age, I definitely would have become frugal much earlier and worked things out to retire in my 40s or even earlier especially as I had to deal with cancer at 42 and that kinda changed how I viewed life!
    Hope this helps. Good luck!

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