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OVERCOMING DELMORE AND SOME THINGS TO KNOW ABOUT RETIREMENT

OVERCOMING DELMORE AND SOME THINGS TO KNOW ABOUT RETIREMENT

March 04, 2019
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At a financial planning firm, the simplest way to describe what we do is we listen to a person’s goals and help them figure out how to pursue them. While that seems easy enough in theory, in practice It tends to be more of a challenge. Life gets in the way, as do countless cognitive biases that we all carry with us. One of the more interesting and descriptive of these, the Delmore Effect, is probably as important as any to overcome. The Delmore Effect, which was described by Paul Whitmore in his PhD dissertation, essentially says that people will set better defined goals in lower priority areas of their lives.[1] Much of this seems to stem from the fact that we like to avoid specifically defining what constitutes success or failure and since, as a general rule, we don’t want to fail, we don’t draw the line. If I say my goal is to eat 2000 calories a day, 2100 is clearly a failure. If I say nothing or just take the easy road and say, I want to eat healthier, then eating two Big Macs a day is a win versus eating three, right? This problem is compounded by the fact that plenty of studies have shown explicit goal setting to lead to measurable behavioral change – so if we’re avoiding setting goals in high priority areas in favor of lower ones, we also end up spending more time and attention in those areas.

When it comes to setting financial goals, the first thing I think you need to understand is the challenge that you face in setting those goals in the first place (recognizing the problem is the first step to recovery) and the second is to get specific about what it is that you’re trying to accomplish. For example, if you’re nearing retirement (even if you’re not and you just want to retire someday), below is a non-exhaustive list of some areas where your financial situation should be well-defined.

  1. Income and Assets that can produce it: These are obviously related – income can come from any place: Social Security, property, a pension, an annuity, etc. Assets that can produce income could literally be almost anything of value if it could be sold and turned into income for you. People probably commonly think of things like IRAs and 401(k)s, but the list is hardly restricted to retirement accounts. Defining your situation in this area is pretty simple – how much money do you need on an annual or monthly basis to maintain the standard of living you prefer? Things to consider: How long do you expect to live? (Everybody thinks this is either a trick question or a dumb one, it’s neither.) How aggressive will your return assumptions be? When should you take Social Security? Lump sum or pension? How tolerant are you of the possibility of having to make course corrections during retirement? (Hint: if you’re not at all tolerant, you likely need to start with pretty conservative assumptions.)
  2. Your tax situation: Whether you know it or not, your tax situation is likely to change a fair amount in retirement. For example, you’ll have no more payroll taxes assuming you’ve stopped working entirely. Beyond that, Social Security is taxed differently than other forms of income. You may have IRAs, Roth IRAs, taxable accounts and annuities – knowing the tax treatment of each is vital and understanding how they interact is equally important. You could potentially save hundreds or thousands of dollars annually just by taking your income from disparate sources in an efficient combination – don’t assume that it doesn’t matter. For those of you retiring prior to 65, the PPACA and premium subsidies are another factor in understanding your tax situation.
  3. Your potential plan killers: Like life in general, retirement is not an easily predictable string of events, there are a multitude of things that can disrupt even the most well-thought out plans. Know them and address them. Medicare pays for a large portion of heath care costs – the gaps it leaves could be very large if not addressed with things like Medicare supplement policies and Medicare Part D (or Medicare Advantage plans, for some). Long-term care events are relatively high probability for a lot of people, but also relatively expensive. Should you choose not to insure yourself against that risk, it should be an active decision and not a passive one. A nest egg that took a lifetime to build could disappear in a couple of years when these situations arise. Decide how to handle this. Unexpected expenses in general all fall under the category of plan killers – new cars, new heating/air units, basement foundation repair, supporting adult children and grandchildren. It’s important to have a plan prior to retiring to decide how you’ll handle these – either by having enough set aside or, in the case of children, saying ‘no.’ If saying no isn’t your thing, it’s important to begin retirement at a level of income well below what your portfolio could produce so that when the unexpected happens, you have room to adjust. Assets don’t produce extra income just because you need them to. Also, on this note, make sure your portfolio matches your goals and risk tolerance more closely than it matches your wildest dreams – hope is not a (reliable) plan.

When you really boil it down, retirement is largely a question of cash flow – one that retirement planning is designed to answer. Just like during your working years, stretching your cash flow more or less manifests itself in a riskier or safer plan. Being more aggressive with assumptions in retirement is okay so long as you understand and are prepared to deal with the consequences of not meeting your initial assumptions. I hope the biggest takeaway from this post is that it’s important to define what success or failure looks like so that you have the capacity to adjust, if necessary. I hope the second biggest takeaway is that, if you like eating three Big Macs a day, you should either pray a lot or stop – probably both. I hope the third biggest takeaway is, if you want to be able to spend as much as possible in your retirement years, eating three Big Macs a day might be the best plan. We’ve come full circle.  

[1] https://medium.com/@hormetic/the-trouble-with-goals-1519ec23f878

This is meant for educational purposes only.  It should not be considered investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.  03/19