Your Annual Date with Reality

Get real. Really. At least annually, get real.

Whether you’re in your working years or your retirement years, the main challenge of retirement planning is figuring out an appropriate amount to save (in your working years) or to spend (in your retirement years). Actually, the main challenge is then sticking to your budget. But the main planning challenge is figuring out this amount. The amount you come up with is bottomed on projections about the future, which will most assuredly not come to pass. They’re just guesses after all. Reality and your projections diverge a little bit more every day.

These divergences come from all over the place. They come from outside your personal life, such as the financial markets (was it a better than projected year for stocks, or worse?); and from events unique to you—an unexpected bonus, a surprise leak in your roof.

So the method you’re using to come up with your saving or spending amount had better have a built-in mechanism for periodically adjusting to cold reality. If you don’t, one of two things will happen. If things go worse than you projected, you will gradually pauperize yourself. If things go better than projected, you will gradually build up an inheritance for your children (the worthless good-for-nothings!) at the expense of the more comfortable lifestyle you could have treated yourself to.

How often should you recalculate? At least annually. You could do it more frequently, like monthly, but you’d drive yourself crazy. Your saving/spending amount would bounce up and down with the same sort of volatility as you see in your 401(k) statement. You’d be seasick in no time. Or you could do it every five years, but then your adjustments would be vertiginous. Annually seems about right. Pick a month, and then set aside some time for your annual review. I don’t like December for this task—too much other stuff going on. January or February seem about right. A good time to be inside; not much else happening then (unless you celebrate President’s Day bigtime); early enough in the year to adjust your elective deferral to your 401(k) plan.

The benefit of annual adjustments is that they will be small in relation to the size of actual events. The younger you are when it happens, the smoother the adjustment. That’s because you have a whole lifetime to make up for (or revel in) the large unexpected loss (or gain).

Here’s a f’rinstance. Remember Ernie from January 21’s post. He had $75,000 in his 401(k) plan, and projected an annual savings goal of $8,426 over the next 25 years. Let’s say instead of earning 6% as projected, his 401(k) account lost 33% of its value, dropping to $50,000 (sound like 2008?). When Ernie refigures his annual savings goal the following year, all other things being equal, it will work out to $10,776 per year for the next 24 years. That’s a $2,350 increase in required saving to make up for a $25,000 loss. It will pain Ernie to reduce his current spending by that amount, but it won’t devastate him.

If you’re in retirement, your adjustment might be more dramatic. That’s a subject for another post.