What You Value When It Matters

“Tell me what you value, and I might believe you, but show me your calendar and your bank statement, and I’ll show you what you really value.” -Peter Drucker

As financial planners, we often find ourselves working with people in abundance. People who’ve been successful in their professional lives, recognized and considered accomplished for their achievements, and happily in a position to make decisions from a place of abundance. But even those who have been professionally accomplished can find themselves in the tricky position of making trade-off decisions. Sometimes these are delightful trade-offs, like whether you’ll plan to spend your next holiday in Aruba or Ibiza. Other times they’re tougher decisions, like whether you’re willing to take on debt in retirement or risk having to cut back during down years in the market.

This week, we’re exploring the framework by which the latter, tougher types of decisions are often made, and whether there’s a case where such decisions may be made easier.

A Case Study

Imagine you are well into retirement. Still young and healthy enough to be active, but not so young that a return to work seems practical should some sort of financial hardship or sufficient boredom befall you! Let’s imagine you’ve retired in relative abundance. You live in a beautiful community in an $800,000 home, you’ve saved $2 million dollars, and you enjoy a healthy stream of income from Social Security that pays $50,000, which gives you about 20% of your lifestyle needs. The other 80% is funded by distributing $200,000 from your investment portfolio.

You might then wonder what we’re spending the $200,000 on. Let’s consider this relatively irrelevant, but for that it funds a lifestyle to which you are accustomed. You travel regularly, spend time with your friends and family, enjoy entertaining shows or performances; whatever floats your particular boat. Suffice it to say, it’s largely discretionary spending of the enjoyable type rather than mandatory minimum expenditures to keep the lights on.

The problem with all of this is, as an astute reader or any financial planner will have spotted, that this is a 10% annual distribution rate. For reference, a popular benchmark distribution rate is 4% (though the academic literature on this subject varies), and in pension plans that receive regular new income from contributing employees, a distribution rate of 8% is considered reasonable. But, given that we’re distributing 10% annually, it follows that we are “overspending” in the traditional sense. In other words, we’re going to run out of money at some point. It may take more than a decade to do, but if we’re long-lived or if a sequence of bad return years hits us at the wrong place and time, it’s not improbable that we’ll find ourselves without any money to spend but for the $50,000 in Social Security income.

What Solutions Present Themselves?

Faced with the real probability of running out of money, you’re put in a tough spot. Abundance affords us a margin of error in our lifestyles and the decisions we have to make, but when decisions become mutually exclusive and what we value comes into conflict, these can be much more difficult choices. So, let’s examine a set of values and questions that might come up in a situation like this:

• Beyond providing for yourselves, is it important to you to leave wealth to your family when you pass?
• Is your current home your forever home? Are you comfortable with the idea of downsizing?
• Would you ever consider taking on debt to bridge over a market downturn or to supplement your income and better preserve assets that are growing more than the cost of the debt?
• Are you comfortable being more flexible with your lifestyle and plans based on how the market and economy are doing?
• What parts of your current lifestyle are non-negotiable, and what parts are nice to have but not necessary?
• How much financial support are you giving to others (family, charity, etc.)? Is that a necessary expression of your values or something you do out of kindness rather than necessity?
• Would you rather maintain your current quality of life as long as possible and then cut back when forced to, or would you prefer to reduce your lifestyle now and enjoy that reduced lifestyle for a longer or indefinite period of time?

None of the questions or ideas above immediately resolve any particular set of financial challenges or decisions, but all of them may present themselves in one way or another. For example, imagine our case study from earlier, and let’s say that the primary driver for the overspending pattern is a desire to see as much of the world as possible. Such travel is enjoyable, but it may also only be practical during a certain period of life and health; for example, riding a bike along the Rhine River in Germany sounds delightful, but might be hard to manage when you’re in your 90s!

Someone with that type of priority might reasonably look at a couple of the questions above as being “now or eventual” decisions when faced with running out of money:

• We’re focused on traveling because we want to do it and enjoy it while we still can, so we don’t want to cut back on that.
• The idea of being flexible with our plans sounds reasonable, but if there’s a market downturn that takes a few years to recover from, then we might find ourselves unable to travel by the time we’re financially able to do so again.
• We could take on debt to bridge over market downturns, but that might also mean leaving behind less wealth to our family. And we could downsize, but we raised our kids in this home; we don’t want to have to sell it!
• We’re people of faith, and we believe in tithing to support our church; cutting back on charity might be practical, but it wouldn’t align with our beliefs.
• We live very frugally, actually; it’s just all the travel that has us spending so much!

You see how any number of potentially viable questions or solutions can be inapplicable in the face of the seemingly immutable need of a presented lifestyle? The challenge is that the last question will become the default answer if no other actions are taken: A household that is overspending will only be able to do so for as long as they have the financial means, and at some point, inevitably, they will be forced to cut back. The only other possible solutions involve wildly risky Hail Mary-type bets on speculative investments or outright gambling; and while the story of FedEx’s survival back in 1973 makes it seem like it’s not a completely wild idea to take all your money and bet it all in a casino in the face of otherwise guaranteed failure, it’s probably not a good idea to bet your remaining financial welfare in retirement on DraftKings.

Prioritizing What Really Matters To You

The exercise above presents a variety of questions and the potentially dismissive (if well-founded) answer to the solutions or strategies they imply. So how do you overcome the inherent limitations that addressing each option in isolation poses? Simple: You order your priorities. Take any variety of options and strategies and rank-order your preferences. For example, your first priority might be to keep traveling because that has been your life’s dream. Thus, no matter what else is under consideration, you’re going to keep doing that.

Assuming you can keep doing that, you then need to decide what else is so important to you that you wouldn’t compromise it, given the choice. You might say it’s staying in your current home, or perhaps it’s continuing to support your faith community through giving. Whatever your particular answer, you can repeat this sequence until any and all elements of your lifestyle and preferences for one strategy or against another are accounted for. At that point, you simply have to run the numbers and chip away at the financial plan from the order of “least important” until such time that the financial plan works.

To be clear, what you chip away at may still eventually leave you with an inadequate set of lifestyle choices. “I don’t want to downsize. I don’t want to travel less. I hate debt.” Take your pick in this particular condition about what you’d prioritize and hate to lose if the numbers told you to make it so, but more problematically, contemplate what the inevitable consequence is: If you don’t make your own decisions now, running out of money will make the decisions for you.

Avoiding Financial Avoidance

Whether we like it or not, not thinking about the unpleasant or difficult thing is a strategy. In fact, it’s a comforting strategy. Maybe we’ll inherit money, win the lottery, or the market will take off at a rate of return that triples its long-term normal average, such that these problems might go away. Or perhaps we’ll just die before we run out of money, and then it was never a problem at all. Much like avoiding the necessity of a proper diet and exercise, it’s not going to be a problem if we simply no longer exist to be burdened by it.

But is that the rational thing to do? To wish unicorns on the bright side or a quickening of the inevitable end on the downside? Hardly seems like it, but that is what avoidance indicates. “I don’t want to resolve my problem now, so I’d rather hope that something else resolves it for me.” It’s an ideal way of avoiding the emotional burden, to be sure, but not one that provides any relief in the event that the emotional burden becomes a genuine real-life burden.

And that’s the key of the thing. In finance, the most powerful tool at your disposal is time. Saving and investing consistently starting when you’re young magnifies your results spectacularly, even if you don’t increase your savings or take on undue risk with your investments. Paying down debt faster reduces lifetime interest costs and leaves you with more net wealth than making the minimum payment, or at least it does in the absence of an adequate offsetting investment of the difference. And the same is true of decisions. Financial decisions made sooner and with greater confidence are likely to produce better financial outcomes. Cutting back now, saving more now, downsizing the house now, moving to a lower-tax place now, whatever the strategy is, it is almost a property of physics that it will yield a better result than the same action taken “later.”

So, do the hard thing. When a decision about your values and priorities has to be made, take reasonable time to consider it and mull over your options. But make the decision that needs to be made, whatever the choice may be. It will yield a far better outcome than simply wishing that the decision needn’t be made. It will show what you value when it matters.