In personal finance, most of the focus gets directed towards the accumulation phase of life. These are the steps you need to take to save money, invest it, and build wealth so that one day you’ll have enough money to live on your terms!
After decades of working and accumulating assets, you’ll enter the decumulation phase of life. At this stage, you’ll determine how to convert the wealth you’ve accumulated into income and use it to fund your retirement lifestyle.
Your primary goals during the asset decumulation phase should be:
The asset decumulation phase presents its own set of risks and challenges, too. Unlike the accumulation phase, where investors can mentally handle market declines by buying assets at cheaper prices, it’s more difficult during the decumulation phase. Experiencing a dip in the market when your ordinary income has stopped and you’re retired can not only affect the size of your nest egg but your psyche, too!
For many people, especially those who have a saving money personality, the transition from accumulation to decumulation can be tough. The mental shift of going from saving money to now only spending it, can be stressful. It may even negatively impact your sense of emotional and financial wellbeing!
During the decumulation phase, you’ll confront 3 major risks. Below, you’ll learn about each of them and how you can protect yourself.
As you transition into the decumulation phase of life, asset volatility becomes a more significant risk. In many cases, your regular income has stopped and a decrease in the market makes it harder to preserve your capital than before.
Sequence of return risk occurs when asset prices fall soon after you’ve retired or stopped working. The decrease in value means you’ll need to sell more assets at these lower prices to produce the same income as before. As time progresses, your capital balance falls more quickly than you anticipated, which also limits its ability to compound and support you for decades to come!
For example, imagine you determine that you need $5,000 per month to support your retirement lifestyle. If asset prices are $100 per share when you stop working, then you’d need to sell 50 shares to generate $5,000 in income.
What if the market drops to $80 per share soon after you’ve retired? Then selling 50 shares would only generate $4,000 in income. You’d have to sell another 13 shares to receive your full $5,000 monthly income, which not only depletes your assets faster but can affect the duration of your retirement, too!
Sequence of return risk is most detrimental early in the decumulation phase since this is the time when it’s most impactful. However, it also lingers for as long as you’re retired and reliant on financial gains to produce your income.
It’s human nature to want a good life and to live for as long as possible. However, living too well and/or for too long during your decumulation phase presents another challenge.
Longevity risk is the possibility of living longer than you planned and running out of money during retirement. With ongoing medical breakthroughs and increasing life expectancies, the risk of outliving your savings is very real!
Today, retirees’ primary concern is running out of money. Most of them fear that they don’t have enough money to support themselves and as they age they’ll become a burden to their families.
Longevity risk is a challenge that you’re likely going to experience as well. After all, there is no way to predict how long you’ll live, what your quality of life is going to be, or the number of future medical treatments you’re going to need – all of which affects the amount of money you’ll need to be able to retire in the first place!
Before entering the decumulation phase, most people have worked for decades and are ready for a break. As they stop working, they’ll become almost completely reliant on their retirement savings, which forces them to have a more conservative financial strategy.
Most financial professionals advise retirees to own low-risk assets which also tend to have low expected rates of return. While these securities are often safe and predictable, they have the potential to expose retirees to greater inflation risk, too!
For example, imagine you’re planning to retire in the next few years. In preparation, you begin reducing your risk by selling stocks and purchasing bonds. However, current bond yields are less than 2% while the inflation rate is over 5%! This results in the purchasing power of your retirement savings falling by over 3% per year. In addition, it now takes more money and selling a larger portion of your assets to sustain your lifestyle!
If you don’t consider inflation risk during the asset decumulation phase, then you’ll have to lower your standard of living in retirement. Otherwise, you’ll risk depleting all of your assets and be facing a serious personal financial crisis!
The actions you do or do not take today will affect the amount of money you have to spend in the future. And the following tips can help ensure you have a happy retirement!
For most millennials, the decumulation phase of life is far into the future. Planning for it means that you’ll make some assumptions about your future monthly expenses, long-term investment performance, and life expectancy.
While there’s no way of knowing exactly what any of these outcomes will be, you can still make an educated guess about each one. And this decumulation calculator can help you!
Accumulating wealth for retirement is pretty straightforward. It involves living like a tightwad so that you’re able to save, invest, and allow the power of compounding to work for you as long as possible!
However, the decumulation phase is often much more complex. It typically involves withdrawing from multiple retirement accounts, being tax-efficient, and making long-term decisions. In some cases, it requires input from your family, too!
By considering these future decumulation risks today, you can begin building a portfolio that’s protected and will last. This way, you’ll have time and money to spend with your loved ones, cross items off your bucket list, and enjoy your golden years worry-free!
Which of these decumulation risks are you most worried about? Comment below.
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