You’re at or nearing retirement and you’re obviously keen to enter this phase of your life feeling comfortable about the future. There’s one question you want answered with confidence – Have I got enough to live happily ever after?

Unfortunately, there’s not a straight forward answer to this relatively simple question. There are many rules of thumb used – these generally range between 12 to 25 times your expected annual retirement spending. Yet, the amount you need is dependent upon your specific retirement goals.

**What are your retirement goals?**

Primarily, most people’s retirement goal is to ensure that they don’t run out of money. However, you may also want to leave some wealth to your children or other beneficiaries of importance. You may find that you have to curtail your own spending to achieve this. The last thing you want to find out is that you’ve under spent and left too much to your estate.

Your ultimate aim is to reach your target wealth at just the right time. Unfortunately, there are a number of uncertainties which make achieving this aim a far more difficult task than it appears.

Take for example, longevity risk. Beverly is a healthy 62 year old woman. Her life expectancy is 86. This is the average age she is expected to live to. However, there is a 50% probability that she’ll live to 88 and a 25% probability that she’ll live to 93. The amount of capital she needs will be highly dependent upon her eventual lifespan. Something we cannot know in advance.

The amount of capital required is also dependent upon the risk you take. Exposure to higher risk assets is expected to result in a higher average return, thereby reducing the capital amount required. But there is no guarantee that higher risk will result in higher return. Higher risk also means greater variability in the value of your portfolio. This can have unforeseen consequences on portfolio longevity.

Finally, your spending requirements in retirement may turn out to be quite different from your expectations.

**Knowing your retirement goals is only part of the answer**

Even with the above issues resolved, uncertainty remains. Consider Beverly’s situation. Let’s say we know the following:

- She requires $70,000 per annum, indexed with inflation each year, for the rest of her life
- She will live for exactly 25 more years;
- She wants to leave no investment wealth in her estate;
- She invests in a balanced portfolio that earns an average rate of return of 7.1% per annum (with volatility of 10.2%) over the 25 year period; and
- Inflation averages 4% per annum.

Surely, with this level of certainty we can determine the amount of capital required for Beverly to know she’ll meet her requirements.

If her annual returns came with no variability (i.e. at 7.1% each year), then we could quite confidently say that she would meet her requirements with a capital amount of $1.201 million (or 17.2 times her annual retirement spending). . Unfortunately, her portfolio returns are subject to variability and the order in which the returns appear has quite a dramatic effect on her ability to meet her objectives.

We used a Monte Carlo simulator to generate random annual returns that matched the average return and volatility characteristics of Beverly’s portfolio. Each simulation produced a series of 25 annual returns that resulted in an average rate of return of 7.1% p.a. over the 25 year period.

This adds an element of uncertainty (and reality) to the situation.

Each simulation run affected the amount of capital required for Beverly to meet her objectives. We picked two runs that were at the extremes to highlight the effect that return variability has on retirement planning.

The charts below show the annual return sequences of two simulations:

Remember that both runs resulted in the same average annual return of 7.1% p.a. The following charts show the cumulative return of each run over time (the blue line). They are compared to the red line showing constant annual returns of 7.1% p.a. each year.

In the first run, the cumulative annual return was initially very low reflecting the poor initial performance. Returns improved in the latter years to end up averaging 7.1% p.a. for the 25 year period. The second run shows the opposite outcome, where returns were much higher in the earlier years.

**What effect did this have?**

If returns occurred as per the first simulation, Beverly would have required $1.560 million (or 22.3 times her annual retirement spending) to meet her objectives. However, if returns occurred according to the second simulation, she would have only required $0.827 million (or 11.8 times). That’s almost half the amount of the first simulation!

Despite narrowing the uncertainties significantly, huge potential variances can still exist in terms of the amount of capital required.

**Retirement planning is anything but a set and forget strategy**

A lot of capital withdrawal strategies are based on the minimum pension percentages set by the Government. This generic approach may suit some retirees but is unlikely to meet the personal objectives of the majority.

The Global Financial Crisis affected all investors, in particular, those in the early stages of their retirement. Many may not have adjusted their withdrawal strategy sufficiently and could be inadvertently drawing too much capital.

In order to give yourself the best chance of achieving your retirement objectives you need a personalised and interactive withdrawal strategy. This strategy needs to incorporate the flexibility required to meet the ongoing uncertainties associated with retirement planning. It is anything but a set and forget approach.