While retirement (or financial independence) projections are a cornerstone of any comprehensive financial plan, not everyone understands what goes into them, the different ways to run them, or how to interpret and make sense of the output. In this episode, we start by providing a high-level explanation of retirement projections, then proceed to do a deeper dive touching on these different items. Our goal with this episode is to help you understand the ins and outs of retirement projections so you can better use and interpret them within the context of your own financial plan.
Outline of this episode
- What are retirement projections? [1:47]
- The 3 phases [4:59]
- Straight-line projections [9:29]
- Monte Carlo retirement projection [13:47]
- Interpreting the results and making decisions with your projections [16:11]
- Building in buffers [20:31]
- The recap [22:32]
What is a retirement projection?
A retirement projection at its broadest level is projecting out to see if the combination of your existing investment assets, planned savings, and future income sources are enough to meet your spending goals in retirement without running out of money before the end of your life. However, there's much more involved given the volume of variables, inputs, and unknown factors about how the future will play out. You need to account for these, which means a retirement projection isn't an exact science and should instead be thought of as an ongoing series of well-thought-out and educated assumptions based on all the available information.
Two types of projection methods
There are two basic types of retirement projections you can run. They use the same inputs and variables, but have a different way of modeling investment returns over time.
The first and most intuitive retirement projection is what we refer to as "straight line" projections. With a straight-line projection, you assume a standard rate of return (such as 7%) and model that out from today to the projected end of your life (we use age 92 for men and 94 for women). The main takeaway with this type of projection is that you assume a standard rate of return that you project out every single year of your retirement plan.
Then there is the Monte Carlo retirement projection, which factors in the reality that you will not have the exact same investment return every year and instead will have a random sequence of possible returns and it runs a thousand scenarios based on those random potential sequences, thus giving you more confidence of possible outcomes and a better picture of where you stand with meeting your goals throughout retirement.
Painting an accurate picture of retirement
We prefer using the Monte Carlo for our retirement projections because it paints a more accurate picture of reality. When running these projections, we target a score of 85% versus a 99% score because we feel it's important to balance enjoying today without jeopardizing your finances in the future. By being too far below 85% or targeting a 99% score, you may be in a position of either having to make tough choices in the future (like having to cut back on spending or risk running out of money) or making unnecessary sacrifices with your decisions today (like working longer than required). By having a score of 85% and checking in each year to make adjustments if needed as a result of your score going above or below that target, you're able to strike a healthy balance and avoid any unwanted surprises down the road.
Resources & People Mentioned
- Download our guide: Retirement Timeline – Key Dates & Opportunities
- Download our guide: Retirement Checklist – A Guide to Planning for Retirement