Range Anxiety

You’ve heard about “range anxiety” when thinking about buying an electric vehicle, right? It is the fear that your car will run out of juice before your final destination. It is a pretty short walk from there to “range anxiety” about your retirement plan. If there is any one question that dominates every other in retirement planning, it is this: “Will I run out of money before I reach my final (and I mean, final) destination?”

Sticking with the EV analogy for the moment, there is one proven way to relieve range anxiety: have a really big battery. For retirement, that would equate to having a large nest egg. The idea is identical: start with a large enough store of power (or money) and steadily drain it away as you travel.

And this is where the analogy breaks down completely. Because in your EV, you know where you are going and how many miles you have to travel. You can look at your battery charge and easily determine if you will arrive safely or be left on the side of the road. Alas, in retirement, you have no idea how long your journey will be and how many detours (both good and bad) you will take along the way. Much of retirement planning is solving this seemingly unsolvable problem.

That brings us to the much-heralded “4% rule.” Based on research, this is the amount (more or less; the debate is endless) that you can withdraw each year from your savings and face little likelihood of running out of money over the course of a typical 30-year retirement.

The central weakness of this guideline (whatever the exact percentage) is that it treats all of your spending as being equal in importance. But clearly, food, shelter, and medicine are more vital than an annual cruise. And so, your range anxiety is not completely relieved. While you may intellectually accept that you can spend $X amount each year (however you arrive at that number), there is still that nagging voice in the back of your head that knows that this is all based on assumptions.  It may still be hard for you to feel comfortable enough to actually take that cruise.

For that reason (and I am certainly not the first to say this), I very much favor the approach of calculating your absolute “must-have” spending and then matching that to a guaranteed stream of income. Or, to turn that equation around, how much of your income in retirement is guaranteed?

Can you arrange your affairs such that all of your critical spending can be covered by a guaranteed income stream?

Almost all of us will benefit from the guaranteed income stream known as Social Security. It may not be possible for you to shoehorn all of your non-discretionary spending into that Social Security envelope, but this is where the difference between claiming your benefit early, at full retirement age, or waiting until you are 70 becomes a key decision. Would delaying your benefit relieve your range anxiety by being able to cover most of your mandatory expenses with guaranteed income?

Others choose to address their fear of running out of power by buying an annuity. What surveys consistently tell us is that people who retire with pensions from their employers (which are an annuity) are consistently more content with their financial lives in retirement.

But there is this thing in financial academic research called the “annuity paradox.” In brief, people absolutely love the idea of a guaranteed income stream in retirement. But they really and truly dislike the idea of tying up a large sum of money in order to purchase this income stream. It’s not at all dissimilar to why some people dislike buying insurance, and guess what? An annuity actually is an insurance, not an investment, product. For that reason, annuities are far less popular than one might expect. (It doesn’t help, of course, that the annuity industry is rife with hard-to-decipher terms and often exorbitant fees.) This is a space to watch as policymakers consider ways for employers to offer simple annuities more easily within workplace retirement plans.

As an alternative, some planners advocate segregating an amount of money away from your regular investment portfolio in a very low-risk environment (CDs, money market account, and the like), which is used strictly for must-have expenses. You have two nest eggs: one that is just for needs and the other one for wants. You can spend freely from the “wants account” (and maybe even take some investment risk with it) because you know that you have your needs locked down.

The funny thing about planning for retirement is that the saving-up part is actually the easier part to figure out. Make regular deposits and let time and math do the work. You are probably better off paying less attention rather than more. It’s when you have to start spending that the anxiety starts.

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