Let’s suppose you’ve had enough of your job and want to retire – tomorrow! What would it take? How could you satisfy yourself that you have the financial wherewithal to walk away from the security of your paycheck?
Before you read ahead, humor me. Play the game out in your head. I don’t want to know if you could walk away, just how would you know if you could?
What did you come up with? Does trying to grapple with such a nebulous issue spread over so many years in the future seem overwhelming, impossible?
I will let you in on a big secret. This is really a very simple question.
If you have a great deal of confidence in your retirement plan, you have probably already figured out what I am about to tell you. If you have no idea what it will take or when you will get there, read on…
Financially, retirement planning boils down to three and only three things: cash flow, cash and insurance. If I have these three things, in sufficient quantities, for an indefinite period of time, I am free to ride off into the sunset.
Really? Could it be that easy? Let’s examine them one at a time…
Cash flow – While you are working, your cash flow comes from your job or your business. When you retire, your cash flow must come from your assets.
In retirement, cash flow sources fall somewhere along a continuum of certainty. At one end, you have near-term Social Security benefits, fixed annuities and pensions. Examples, on the other end would include rental income, oil and gas royalties and investment income from your portfolio.
The number one job of a retirement portfolio is to produce the cash flow necessary to fill any gap between your retirement expenses and guaranteed sources of income.
Cash – Every household needs a stash of cash held in a readily accessible, risk-free parking place that can be drawn on in the event of an emergency. Ours is held mostly in interest-bearing savings accounts, CDs and ultra-short bills, bonds and commercial paper. This particular bucket of cash is known as your emergency fund.
The emergency fund has a single job. It is to smooth out the ups and downs of markets and the economy. While you are working, that means the emergency fund is used in the event one or both spouses lose their job, became disabled or otherwise can’t work. In retirement, the job of the emergency fund is to smooth out the inevitable fluctuations in investment income.
Insurance – Insurance is a mechanism by which we pool together risks we cannot afford to insure individually.
When you are in your 20s and 30s, the most common insurance needs are property, casualty, life and health. In your 40s and 50s, you need to purchase long-term care insurance. In your 60s, life insurance will often become unnecessary but you will have to grapple with Medicare and Medicare Supplement insurance.
The number one rule of insurance is, if you cannot afford to pay for something, insure it. If you cannot afford to replace your house if it burns, you insure that liability. If you cannot afford a lawsuit, you insure the liability. If you cannot afford years and years of long-term care, you insure the liability.
The second rule of insurance is the less you can afford to spend money on an insurance premium, the more you need insurance.
Think about it, if you can’t afford $500 for car insurance, you sure can’t afford to fix your car if it is in a wreck. If you can’t afford $400 a month for health insurance, then you certainly can’t afford to pay all the doctor and hospital bills if you were badly injured in that wreck. And if you can’t afford $5000 a year in long-term care insurance, you certainly can’t afford to pay for home health care, home modifications, physical therapists and skilled nursing care for the next 30 years if you were permanently disabled in that wreck to the point you needed long-term care.
So let’s revisit… Cash flow is your life blood in retirement. It is what pays the bills. Not your net worth. Not the number on the top of your statement.
In retirement, the only thing that matters, (except to your heirs), is the money coming into your account that is available to sustain your lifestyle. Without it, you die. On the other hand, so long as you have plenty of it, you can easily and comfortably maintain your standard of living indefinitely into the future.
Cash smooths out cash flow. The more uncertain your cash flow, the more cash you need to have. If you can live very comfortably on Social Security, Medicare and your pension, your cash requirements will be smaller. If you retire at 45, you are still carrying a mortgage, a pile of debt and all of your cash flow comes from your investment portfolio, you cash needs will be much, much bigger.
Finally, insurance protects your assets, your sources of cash flow and lifestyle, from catastrophic loss. If you can’t afford to lose it or pay it, even if the chances of a loss occurring are very small, it must be insured.
So, back to my original question… you are tired of working and want to know if you can retire. How do you know? Simple. The question is do I have enough?
Enough cash flow?Enough cash?Enough insurance?
If you are short in one or all of these three areas, put your nose to the grindstone and create a plan to get where you need to be. The good news is you don’t have a million things to focus on – there are only three: cash flow, cash and insurance. With enough of these three, you can take care of everything else.
Provided the answer is yes, you have plenty of all three, well then… you go find your sweetie and ride off into the sunset!