By Brad Thomason, CPA
Today I want to point out something that you might not have ever thought of. I say that simply because it’s a point I seldom if ever hear anyone else speaking or writing about. Anyway, here it is: when you are looking at planning at the household level, it is the death of the second spouse that is most significant for income purposes.
Don’t read that as “the death of the first spouse doesn’t matter.” Of course it matters. But the point is that the period over which income is needed will be defined by the second death, not the first.
I am endlessly having conversations with guys who list out for me all of the relatives they have ever had who died before reaching the age of X. This is provided as some sort of proof that the speaker will not live longer, either (though in about half these conversations I’ve had over the years, the person telling me the tale is already older than the genetic clock has ordained…). I listen patiently. Then I remind him that none of that has anything to do with his wife’s prospects for a long life. After all, presumably (though I NEVER point this out), she has different genetic lineage. A somewhat surprised and embarrassed look usually comes into being; they typically stop talking. A few tell me, obviously chagrined, that I’ve raised a good point.
Which is the point of bringing it up here. In most cases, one spouse lives longer. It’s not always the wife, nor does that even matter for what we’re talking about. What matters is that the household is going to need income as long as either one of them is alive.
That’s the basic message. But now that you’ve got that, let’s move on to the master class.
Let’s assume that there were some reliable way to say that a person had a 20% chance of making it past such and such an age. I’m not aware of one, but let’s pretend for purposes of this little exercise, ok?
OK, so here in our mental laboratory there’s a 20% chance of living past, I don’t know, let’s say…92.
If there are 40 households, which we define as being made up of a married couple, how many households would we expect to run out of money if all of them only planned for income through age 92?
Did you come up with 8 households? 40, times 20%?
Sorry, but that’s not the right answer.
The correct answer is 16 households.
How? Because 40 households is 80 people. And 20% of 80 is 16.
The first-to-die from each household most likely lands in the 80% who don’t make it to 92. If you want to think about it in simplified terms, if we just snap our fingers and all the husbands are gone (sorry, guys) then we are already at 50%, 40 deaths out of our original population of 80. But notably, all of the households still need income at this point.
As the statistics play out over the next few years, the number of households goes down. But once we reach the point of 20% survivorship, there are still 16 people; and the odds are that most if not all are living in different households.
It is fair to mention that if we played this out many times in real-world groups of 80 we would see some that worked out this way, and other cases where both spouses in a household lived to be 95 while their neighbors across the street never made it out of their seventies. And so forth. But don’t let the possibility of different permutations get in the way of understanding the core principle. There is nothing in the assumed probabilities which would be violated if the final 16 survivors were all living in different houses. That’s the important take-away here.
This is but one of those situations in the retirement puzzle where the actual outcome is different than what it appears to be on first look. It serves as a good example of why it takes time to really dig into the details, in order to do the job as well as it can be done. Sometimes you have to give yourself time to realize that what you thought was the right answer, really can’t be.
Couples need to remember that they are planning for the income needs of the household, not the individuals. While doing that, they need to further understand that any predictions or assessments they make about the odds of running out of money have the potential to actually be twice as much as they predicted, due to the mechanical aspects of one spouse likely dying before the other.
By Brad Thomason, CPA
Did you realize that stocks are basically worth exactly as much right now as they were a year ago?
Wait a minute, you say. I thought that there has been a big run up this year.
There has been.
It’s just that in the final 10 weeks or so of last year, there was a big drop, too.
Despite the fact that we have indeed had new all-time highs on the Dow this year, most of the gains have just been a recovery of already-gained ground that was lost as we went into the final weeks of 2018. And those new highs? Just a few points higher than where we got to last October. This year’s 27,400 level (which we’ve flirted with a few times) is not much of a jump from the 26,950 we had in the first week of October 2018.
All of the fluctuation in between may or may not have meant anything to you. If you did not change your holdings – in other words no new money in, nor the withdrawal of any of your existing capital – the last twelve months have been flat for you. No net change (even if there was some heartburn and/or excitement along the way).
If you added to your portfolio, you may have had the opportunity to do so at lower levels; and if so you have some sort of gain on those dollars, even if not the rest.
If you had to take money out though, you may have had to do so during the dip, in which case you traded in the shares for what were essentially discounted dollars. The amount you ended up having available to spend (on whatever you needed the money for) was a lesser amount than you would be getting today if you were redeeming at post-recovery levels.
There are a couple of quick items I’ll mention merely as food for thought. First, the scenario I described affects more investors these days than it might have a few decades ago, due to the popularity of index funds. Even though the index levels have not had a lot of net change, the amount of rising and falling of the individual stocks that make up the totals has been much more active. It always is. Which on the one hand is part of the case for using the index fund in the first place. It mutes the effect of those individual movements.
Those movements, however, are where the potential for profit lies, especially during times that the market as a whole is not going anywhere. Just as with any other form of insurance (because that’s what a diversified portfolio is, whether you divide it up yourself or buy the diversification prepackaged in a fund or ETF), there’s a cost. Creating a situation in which you might lose less than you would have, comes at the expense of possibly earning less than you could have. Although the following statement is Monday-morning quarterbacking of the most brazen sort, it will nonetheless be true: Many investors over the last 12 months would have seen much more growth had they been holding a self-selected basket of individual stocks, as opposed to the prepackaged basket of a large index fund.
Second, if you feel like you are getting too old to be dealing with ups, downs, years of zero return without any reduction in capital risk, and conundrums over index funds versus individual stocks, well, you’re probably right. The general presumption as people get older and move closer to retirement is that the balance of the retirement savings will get bigger. It may not be possible to drive these balances to high enough levels without accepting some exposure to market risk during the working years. But as people approach retirement age, especially if the investment campaign has been successful, the attention should turn from making more to protecting what you already have. There is a point in just about every case where it becomes difficult, if not impossible, to continue to back the argument that equity holdings are suitable for the situation. When that happens – and preferably just before it happens – folks should consider an orderly retreat from such investments.
The stock market has been responsible for a lot of capital growth and the funding of a lot of retirement needs. It has been reliably up-tilted throughout all of modern American history, and is likely to continue to be. But not in a straight line, not without weird periods of unusual return activity, and absolutely never without an element of risk of loss.
If you are in the part of your life when you are still growing your balances for some far-off future, spend some time contemplating the pros and cons of being all-index, or perhaps mixing in some tactically-selected individual holdings, too.
If you are in the part of your life when it seems prudent to exit equities, or at least seems onerously stressful to stay, then maybe it’s time to listen to that little voice and plot a course to transition your capital into holdings that behave differently.
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