Your Balance Sheet

Your household has a balance sheet. As you may recall from accounting courses you took along the way, a balance sheet has the assets listed on the left with liabilities listed on the right. That balance sheet for someone approaching or already in retirement might look like this:

Assets:   Human Capital    Continuing career    Part-time work    Encore career   Home Equity   Investments Bank accounts Mutual funds Real estate   Insurance Cash Value   Annuities   Social Capital Social Security Medicare Pensions Family Community

Liabilities:   Fixed Expenses    Basic living expenses Taxes Debt payments Discretionary Expense    Travel    Leisure Lifestyle boosts   Contingencies    Long-term care    Health care    Spending “shocks”   Legacy Goals    Family    Community

Everyone’s balance sheet will have a different dollar amount next to each of these assets and liabilities, but there are two key ingredients for solid retirement income planning. The first is to make sure the assets cover the liabilities. If they do not, some adjustments need to be made to one side of the ledger or the other. The second is to match the liabilities with the assets in the most “efficient” way possible. By efficient, we mean with the lowest likelihood of failure, the lowest tax bill, and always having some money on the table. Even if you are well beyond “enough,” the more efficiently you manage this process, the more you can put toward your legacy.

Tapping Your Assets

You can use your assets to provide funds to spend in retirement in many different ways. Money is fungible, and while there are transaction costs and taxes to consider, you can often change it from one form to another relatively easily. For example, if you prefer to accumulate your assets using mutual funds and spend them as real estate rents, you can simply sell your mutual funds and buy income properties upon retiring.

But even for a given asset, such as home equity, there are a number of different ways you can use it to match your liabilities. By keeping your paid-off home and living in it, you can reduce your basic living expenses and then use the value of the home when you die as part of your legacy. You can sell the house and move into something smaller, investing the difference to help provide retirement income. You can take a reverse mortgage on your home at some point and invest that money, hopefully earning a higher return than the home equity would provide you. You can also take out a home equity line of credit (HELOC) and spend it as you go throughout retirement.

One asset, many different uses. Which is best? Well, it depends on the entire picture of your household balance sheet.

Two Schools of Thought

Here, like the person whose ideas I’m borrowing, along with many widely read authors including Wade Pfau, two philosophies exist. The first involves more risk over time, but potentially better investment returns. Compare that with an arguably safer approach where the focus in on less volatility and more guarantees.

In my opinion, both are legitimate, with the level of legitimacy for you being determined by two things. One is your propensity to accept a level of risk which is somewhat determined by your financial skill sets and the number of years you have left to live. The second is a function of your age and how much financial peace of mind, coupled with a potentially lower rate of return being likely. Some folks don’t like downside risk while other will accept more risk of failure. Both are ok but where are you on the risk continuum?

To some extent, the determination of how much to apply to both approaches is a function of your age and how much money you’ve have available to satisfy  your life goals going forward.

Everyone needs to spend time trying to decide where they fit on the continuum between investments and insurance. The pressures to cause you to decide will likely come from those in the money business whose livelihood is based on their ability to persuade you their way is better than someone else’s approach to success.

As a financial planner for many decades, one of the changes I made in my thinking about this is that as my personal time horizon shrunk, I became less inclined to accept risk. And since I have the skills to find the best insurance options on the planet, I can come really close to excellent returns with elements of safety built in.

Another change in my thinking is when longevity entered the mix. For many years, planners used life expectancy as a determinant of where to put their clients’ money. Then we shifted and age 100 became the determinant. If you’ve spent all your money by age 78, and are alive and well, but broke, you have a problem.

As someone named Bill Bernstein is reported to have said, “When you’ve won the game, stop playing”.  It’s important to understand where you and your advisory team sit on this continuum.

The same Wade Pfau expressed the 4 L’s as the following:

• Longevity: Make sure your assets can provide your essential expenses for your entire life.
• Lifestyle: Allow you to life “the good life” in retirement.
• Legacy: Leave something behind for the people and causes you care about.
• Liquidity: Make sure you’re covered in case something bad happens.

Ending comments: my source for what appears here is a blog post by a Dr. James M. Dahle which appeared in my inbox on March 11, 2022. You can find it here: https://tinyurl.com/yrz42cxr