There is this thought that has been bouncing around my head for a while but I could never really articulate it in a way that made sense. Well, I think that has changed and I can thank Moshe Milevsky of The Schulich School of Business at York University for helping put the idea right in my mind.
When we do any financial plan for a client, one of the first questions we ask is, “How long do you expect to live?” It’s the greatest unknown of life, so it’s one of those questions without a real answer. None of us walk around with an expiry date stamped on us, after all.
As life expectancy has risen with improved health care, I’ve typically pushed healthy clients to consider 95 as the age we should use when planning. It’s a wild number for most people to consider, especially as they sit on the cusp of retirement and they do the math. “You mean I will be retired for 30 years??” is a question I have heard more than once.
No one reaching retirement had ever considered that their savings may need to last 30 or more years, so it’s going to require a big change to our mindset as we start to come to grips with what Prof. Milevsky calls Portfolio Longevity.
Portfolio Longevity is a simple math equation that helps to determine how long your current savings will last after considering your withdrawal rate and the returns on your portfolio. Prof. Milevsky and Steven Posner showed how to calculate your own Portfolio Longevity in this 2014 paper in The Journal of Retirement.
Beyond the math, the concept is an important one when considering how to properly allocate between stocks and bonds. In a world of ultra-low interest rates, the old industry rule of thumb of matching your bond allocation to your age just doesn’t cut it anymore. If 70% of your portfolio is invested in bonds earning nothing after inflation, your Portfolio Longevity will shrink. The risk of running out of money is one of the biggest worries for any retiree. Having money that will last for a 30 year retirement requires a different way of thinking than what we used just twenty years ago.
The concept of Portfolio Longevity also meshes well with Sequence of Returns risk which I talked about back in January. How long your retirement funds will last is something everyone should know. It’s a number that I will incorporate into my financial plans because it just makes things so much clearer and answers that nagging question every soon-to-retire person has asked. Will my money last or not?