Recently, I saw a question posted on an internet forum that caught my attention. The poster who was asking had recently sold his business. He simply asked, “Can I retire?”. He offered the following information:

58-year-old couple
Have $1 million in cash and an IRA with $1.1 million in Vanguard Target Retirement 2030 fund.
15-year $130,000 home equity loan at 2.3% interest.
Social Security at age 67 will be about $7k per month.
Needs $75,000/yr. for basic living expenses.
Need $25,000/yr. for health insurance.

The answers that the poster (I’ll call them the Joneses) received largely affirmed that he and his wife would likely be able to comfortably afford retirement, although many of the responses, while seeming genuinely intended, made some common financial planning mistakes.

I took his information and created a hypothetical client in my financial planning software, MoneyGuidePro®, to help illustrate four mistakes that I noted in responses that he received online. Please keep in mind that the following observations are for illustration and education purposes and should not be considered investment advice.

1. Half Are Below Average

Several of the responders observed that the Joneses’ income needs of $100,000 are only 4.7% of their investment total and that averaging anything over a 4.7% return would equate to success. While the math sounds very straightforward, keep in mind that when you calculate an average, typically about half of the outcomes are higher and the other half are lower (Half are actually below the median, but we’re not being too technical). To account for this, financial planners use a computational technique known as a Monte Carlo model to approximate real-world results through random sampling and statistical analysis.

In simple terms, you can think of a Monte Carlo model like a deck of cards. In this deck, each card represents a one-year return within the range of expected returns. The arithmetic average of the cards in the deck is equal to the expected return of the portfolio. The number of cards in the deck is the number of years you expect the plan to last. The Joneses have an actuarial chance of 50% that one of them will still be living at age 93, so we’ll start with 35 cards to represent that many years in the planning timeframe. The range of returns would be defined by a statistic known as the standard deviation, which I will refer to as volatility. Returns and volatility on similar assets can be observed historically, but typically we try and err on the conservative side when projecting returns and assume volatility will remain about the same. For the Joneses’ current allocation of 33% stocks, 18% bonds, and 49% cash, I would assign an expected return of 4.57% with a standard deviation of 6.14%.

For you engineers out there, that equates to assigning expected returns of 7.5% to stocks and 3% to bonds/cash.

A Monte Carlo series of returns illustrated as deal from a deck of cards.

With that information, we can start playing the Monte Carlo card game. We deal out the entire 35-card deck. Then we start the simulation with their investment total of $2.1 million, each year withdrawing $100,000 of income and applying the returns in the order the cards were dealt. At the end of each simulation, we shuffle, deal, and do the math again until we have done it 1000 times. Any simulation that ends with money left at the end is a success, and those that run out are a failure. With the Joneses current allocation, they are successful in 86% of the simulations. It’s important to remember that the average return of every simulation is the same, it is just the order of when the returns occur that varies.

2. Forgetting About Inflation and Taxes

While 86% would generally be considered a very good planning result (70%–90% is considered “confident”) in a Monte Carlo simulation, we haven’t taken taxes and inflation into consideration yet. Those were also frequently overlooked details in the online responses that the Joneses received. Adding in a 2.5% inflation rate (which is slightly above the Federal Reserve’s stated target of 2%), along with taxes (assuming the Joneses take a standard deduction) on earnings and IRA withdrawals, dropped the ratio of successful outcomes to only 30%!

30% success rate Monte Carlo illustration of $100,000 per year of income from the Joneses’ current portfolio adjusted for taxes and inflation.

The most common way to offset inflation risk is to invest in assets that you expect to earn more than inflation. For our purposes, that means investing more in stocks and less in cash. If the Joneses were to invest 60% of their investable assets in stocks with the other 40% in bonds, their expected return would increase to 6.03%, while the standard deviation would increase to 11.51%.

Playing the Monte Carlo game with this new deck of cards, the Joneses success rate increases to 44%. That isn’t a great result, but it is significantly better than 30%. While we could likely increase the Joneses’ chances of success even further by further increasing the ratio of stocks, we should probably see if correcting the third common mistake solves the problem without taking more risk.

3. Discounting the Impact of Social Security

Many people I talk to like to assume that Social Security won’t be there for them in retirement. Similarly, most of the responses to the Joneses’ question didn’t factor in those benefits when responding. In the 2022 Social Security Trustees report, it was indicated that if Congress doesn’t act to shore up the program before 2034, retirees will receive 77% of their full benefit, and that is likely a worst-case scenario.

The last time Congress addressed the program’s solvency back in 1983, they raised the retirement age (a stealth benefit cut) and started taxing some of the benefits. Those changes impacted younger people much more than current or soon-to-retire participants and likely would be the path that politicians will follow once they decide to stop kicking the can down the road.

For the purposes of planning for retirement, Social Security is still a powerful inflation-adjusted lifetime income that can go a long way towards reducing uncertainty. The Joneses indicated that they will have a benefit at Full Retirement Age (age 67) of around $7000 per month. So, I added a monthly benefit of $3500 for each of them to the plan to see how that changes their probability of success.

That increased the Joneses’ successful simulations to 97%. Even when I reduced their Social Security benefit by 35% to simulate Congress screwing things up (I know, totally unimaginable), they still succeeded 84% of the time.

4. Not Sweating the Small Stuff

Finally, other seemingly small details the Joneses mentioned also made a significant difference when factored into their plan. Many times, these little things can seem insignificant, but they can often have an outsized impact on the results. I estimated what their healthcare cost would be after Medicare starts at age 65 based on the current cost of Medigap and other out-of-pocket costs typically incurred by recipients. I also used a higher inflation rate (5.3% has been the average healthcare inflation rate since 1970, according to the US Bureau of Labor Statistics) for healthcare expenses. As a result, I reduced their $25,000 healthcare estimate by $14,000 per year once Medicare started at age 65.

I also assumed that they would pay off their home equity loan after 15 years, which further reduced their income need by an estimated $10,000 in principal and interest payments afterwards.

After making those inputs and leaving the 35% reduction of their anticipated Social Security benefits, the Joneses had money left at the end of 98% of the scenarios. Leaving Social Security unchanged, they never exhausted their resources in any of the simulations.

Monte Carlo illustration of proposed portfolio of 60% stock/40% bond portfolio, including 2.5% inflation, taxes, Social Security benefits, and adjustments to spending after debt is paid off and Medicare begins.

Of course, there are other risks that can (and should) be added to the model. Higher inflation, long-term care expenses, living too long, or poor market returns are all potentially detrimental circumstances that should be understood. In fact, as life happens or we contemplate all the “what ifs”, plans often need to change to reflect reality. Online forums (and even blog articles) can help in understanding some of these variables, but they can’t replace a personalized plan that considers your goals, resources, preferences, risk tolerance, and intangibles. If you don’t have a plan or haven’t reviewed it in the last year or so, get in touch if you would like some help keeping up with the Joneses.