Should we consider chunking up retirement into different phases ?

One of the things about the Trinity study (akka the ‘4% rule’) was that it made the assumption of a fixed (corrected for inflation, so growing) annual amount taken out of a fund for life. In the case of the study this was arguably around 30-35 years.
But retirement is just not like this. There are several factors that can significantly change the amount we need on an annual basis, especially if we retire early which is the whole point of FIRE after all !!
For example:
  • Mortgage – we may still have a mortgage to pay off so clearly when it does there will be a corresponding drop in required income
  • State pension – whether in the UK, USA or elsewhere there is invariably some element of state pension provision. For us in the UK it is 67. The UK does not have a particularly generous provision but for my wife and I combined would cover much of our essentials, so a fairly sizeable drop in required income from our funds
  • Age related spending – the one factor almost everyone ignores, forgets or just does not realise is that as we get older we spend less. There are lots of studies and logically spending starts to reduce in the 60’s accelerating in the mid 70’s on. In one way this is obvious- we may go out or away less, reduce to one car, downsize our house etc etc. Some studies I saw  put the real terms reduction in spending of 53% of our peak spending which was deemed to be around mid to late 50’s (I should have saved the links really).
Now factors such as paying off the mortgage will have a big effect.
Our mortgage is between 22-25% of our annual spend depending on holidays. It ceases naturally in 6 years but we will have the chance to pay it off completely when I finally wind my late mothers estate up shortly. I considered the merits of paying off early rather than investing and it really does depend a little on your tax situation, but is invariably a better option.
Logically, FIRE is about getting rid of debt and reducing spending requirements after all.
So why chunk off and how big should the chunks be ?
Well, I cannot see myself getting much past 76 years  (20 years from now – just not in my family genes really). My wife has better lifespan genes and should make another 10 years more. So our time window is really 22-26 years perhaps before care-homes and la-la land. Three chunks would be 7-8 years, Four chunks would be 5-6 years.
Now economic cycle’s vary from sector to sector and range from 6-9 years arguably. We are not at the bottom of the CV-19 crash worldwide I personally think, but I would expect by the middle of 2021 we will have passed the worst. In some areas green shoots are there, in others the mud is still settling. I read today that 20 large UK companies have no plans at present to return staff to offices and more than 50 large companies feel only some will return – a sea change is afoot and working from home (WFH) will become a new norm. It is however open to question as it just depends how big the unemployment spike will be and how quickly large chunks of the economy start to recover.
WFM means remote working. Remote working means ‘anywhere’. I don’t think people have quite realised both the opportunity and the risk. Opportunity to semi-retire and work remotely from ‘somewhere’ and risk, as ‘somewhere’ can mean anywhere on the planet…. and that risks outsourcing. All this race to flexible homeworking opens the door to job losses as functions move around the globe to the cheapest operational points.
All you people loving Working From Home, think it is great to never go to an office again….. Be careful what you wish for !
Anyway, the next bull (essentially the rapid rise of the V-model) will most likely be over the next 6-8 years. It seems to make sense to pick a 6 year window, not least because if I choose not to pay off the mortgage (and that really does not make sense) then it lasts 6 more years. This also makes the chunks more meaningful looking at how our future activities phase.
So for us (56 years old) we have essentially five periods:
1 – 56-62 …. takes us to the end of the mortgage period if I don’t pay it off
2 – 62-68 …. just taking us into the state pension provision
3 – 68-74 …. spending starting to fall
4 – 74-82 …. more spending fall + early care/support provision
5 – 82+   …. la-la-land !
Note if I made the chunk 8 years I would have 56-64; 64-72; 72-80; 80+. These just don’t line with the major financial dates of mortgage, pension or real personal slowdown. So for me, the above 5 chunks looks good so far.
Lets see what comes of some numbers ….
Whenever numbers start to fly about, inflation, NPV calculations etc there is a tendency to just loose sight and sense of the bigger picture. So right now I am going to ignore inflation effects and just look at absolute change.
Note: there is only one goal in simulation really and that is to gain insight to ‘the picture’. Anyone telling you it is to get absolute numbers, or ratios of this that and the other is just plain missing the point.  So whilst including inflation may give you a measure of the absolute (ie cash in your bank), it gives no sense of relative scale or what variables have a large (or small) effect. I am good with numbers so being a bit geeky, I do like to run an absolute calculator, but I always start by taking common variables out and simplifying. You need to feel the differences or you can never really get a sense of scale or whether you broadly have the picture right. Absolutes can point to errors and discrepencies as well as they compound more rapidly.
My view on this approach is the following and anyone looking at a bit of simulation or ‘what-if’ would do well to do this:
It is not the absolute numbers that matter so much as the relative picture. By removing inflation effects from spending and growth you can essentially compare any age to any other more clearly. It is not absolute, just broadly relative and as time goes on the margin for error increases, but the phrase ‘there or there-abouts’ is a good one to keep in mind.
Ulta-exact calculations and forecasts are just not possible really. What we need is something that gives us a sense of scale and likely window of outcome.
So how does it all stack up for us ?
Rounding a bit for simplicity, our current annual spending budget is circa £48k. This includes around £10k for the mortgage, £9K for holidays, and about £6k for misc, local restaurants, going out etc. It ignores exceptional’s like, for example we are just about to change both our cars. More on exceptional’s later
I had calculated the minimums for a very basic living of circa £18k + mortgage. Only thing different so far this year is that we have spent only £2K on holidays and about £2K of the misc, but for this I am going to assume a more normal year estimate of £38K + £10K Mortgage as the basis to calculate.
My wife has a modest index linked pension of circa £7K indexed at 2.5% or 0.7% above inflation – just gonna ignore that extra growth. So we have a NET need of between £31K and £41K pa (depending on mortgage).
Although our state pensions kick in at 67 at various times in the year, for simplicity and erring a little high I shall assume they kick in at 68 for a full year. Current NET value (assuming full taxes payed) will yield around £13k NET (isn’t the UK great !!!). It is likely in real terms to be a bit more, but I like to always err with a positive margin to give extra headroom – it is after all a picture you look to see and nothing is absolutely certain.
Because I have removed inflation effects (ie bills going up etc) I can simply multiply the required year 1 figure by 6 and arrive at an inflation adjusted zero growth fund requirement for each period. Clearly though, some level of growth either would reduce the need or increase the headroom (a better outcome).
Thus, I have a net fund requirements for each period of:
1 – £246k (£186k if mortgage cleared)
2 – £186K
3 – £108K
4 – £108K
5 – £18K pa
So just on raw numbers, around £650K to the age of 82 then £18K beyond.
Remember this assumes I lump money in a bank and it grows only at inflation, and all bills just grow with inflation.
But then we need to factor in the reductions for age. From 68-74 a real terms reduction of around 1% pa is widely muted to around aged 74/75 and 2% after that. The sniff test sort of makes it feel about right. It is probably during this time we will go down to one car. Very probably will will have downsized and our home costs fallen. Probably some level of travel will have reduced. there are no absolutes and it is the bigger picture I am really interested in.
So period (3) would need perhaps around £106K and period (4) about £100K. Overall this changes very little meaning a fund of circa £640k and an annual depreciating need of £16k from aged 82.
All meets the sniff test if you really think about it: more front loaded spend and then rapidly decreasing need as state income kicks in and outgoings reduce.
Note: remember it is NET Fund as it is the NET amount needed. The actual fund would be potentially larger depending on taxation
Now I can start to chunk up my investments into variables of risk, income and growth. I can keep the inflation adjusted in place. So if for example I had a holding with a growth of 3% pa and inflation was 1.8%, then my net growth is 1.2%. If this held for say a 12 year period taking me to period (3) then whatever I start with today would have grown by a factor of (1.012)^12 or 15.4% in real terms. So if my fund need is £108 in 12 years, then I need to start with £93.6K today.
Similary for period (4) using the same numbers I would need £87k and for period (2) £176k.
So taking this and reduced spending into account I need net funds today of:
1 – £186k  (assume the mortgage is paid off)
2 – £176K
3 – £92K
4 – £81K
5 – need 16K pa – even living to 90 this would only be around £100K needed.
Just think… a very modest 1.2% annualised return on whatever inflation there is means an initial total pot size over 16% less. Who would think such a time annualised return compounds so much !
Clearly with differet risk/reward profiles for later periods then higher growth is possble and a lower initial fund needed. That does carry risk, but over a 12 year period, it is hard to loose money if properly diversified.
Right at the start I mentioned the Trinity study and the old ubiquous ‘4% rule’. If I assumed my mortgage was paid off and I needed £31K (net) this year, then that would equate to a fund requirement of circa £775K. In the UK, the 4%  was really the 3.3% rule (as generally long term USA returns have been better) so that would be a net fund need of circa £940K.
Both these numbers are a long way higher that the £535- £635k range above. That is because I have taken account of the natural reductions in spending, the breakpoints in income changes and actually thinking about what will sensibly be needed. Many SWR schemes are arbitrary, generic and do not take into account large spending/income changes over time. They are not wrong, just a more basic model.
That current £31K as a proportion of the fund needs to 82 and 90 years old equates to an initial withdrawal rate of 4.9% and 5.8% depending on lifetime expectancy: way more than the Trinity study suggests, but for period 4 the effective WR could be argued to be 3% (18k/(186+186+108+108).
The Trinity study and articles around it serve a useful start point to just look and see, but the SWR depends as much on income and lifestyle breakpoints as it does on long term returns. I have assumed a return of 1.2% above inflation. Not quite as low as gilts but certainly in the A+ bond range. Factor in some long term funds into some risk and before you know it the start fund is even less.
Exceptional’s – If for example you lease cars, then it is easy to simply factor the monthly costs straight into a calculation, but if you buy, then it is rather more problematic. I did consider adding a ‘contingencies’ line item to my calculator but frankly it seems a bit of overkill. We have more than the above suggests and there is a decent sized additional pension fund my wife has not touched and we plan to just grow as a reserve so really, just not bothering. Same with things like the house boiler needing changing, new carpets, the patio & garden re-modelled. Just park and create a separate fund somewhere with lower risk profiles growing a little over inflation and you will be pretty unlikely to have a problem.
In Summary
In earlier articles I have looked at what we need and a rough profile, but I never really considered going further and actually arranging my funds in phases. Actually rather makes sense to do this as different time-frames and ages have different risk and reward profiles.
I started by considering whether chunking up fund needs into retirement phases was a useful thing to do. It certainly makes sense to me. Phase (1) I will have a mix of low risk, low return investments; Phase 2, perhaps a little more risk; Phase’s 3 & 4 I can afford to take some wider equity risks and phase 5 potentially some bigger risks. This does not mean being wild and just buying startup high-tech stocks, just taking a slightly wider view of risk, time and returns.
In another article I am drafting looking at 3 of the largest UK banks (Lloyds, HSBC and Barclays) a fairly decent return and enhanced dividend income stream is very possible with pretty low risk over 10-12 years.
Even right now, with depressed markets, reduced or frozen dividends, possible large losses over the next 18 months, there are many unloved, unfashionable, good income potential stocks that have a solid base to grow modestly with good yields re-invested. From where I sit, this does rather make me feel that all our retirement plans are possible just starting with an initial fund of £500K or so. We do have more than this, but that just decreases risks and gives us much wider possibilities.
It is looking for and using these unloved, decent value holdings to generate future income streams that is one key to lower risk, sustainable income in the future. Investing is a minimum of 5 years and really 10+ years activity. Anyone looking at less time is really a trader or punt opportunist (and good luck to them). Look at Buffet – just bought a few $billion worth of 5 Japanese companies he intends to ‘hold forever’  (or at least over a decade).
In short:
    • Look at your likely life spending and non variable income profiles
    • Ask yourself, if it makes sense to split your retirement investments into phases
    • Look at basic returns and then start factoring modest risk changes over time
    • Look beyond the old 4% rule and ask yourself ‘how much’ and ‘when’ ?
    • Create a separate ‘Exceptional Item’ fund to grow away and give you the reserve – keep your normal life calculations clean and simple: far easier to manage that way.
I think for most people, you will surprise yourself at how little you really need to sustain a really comfortable and active retirement.