When I started in the financial services business I was very fortunate to pair up with three successful financial advisors who became my mentors.
I am grateful for the time I spent with them because they taught me a lot and encouraged me to continue in what is a very challenging career, especially in the beginning. Each had unique expertise and a different approach to how they connected with clients. One of my favorites, we will call John, often spoke of the Four Horsemen of Financial Planning or the four things that could derail our clients, and what we needed to watch out for and plan for.
It is a little dramatic, but we often need to be shocked into the reality ahead, and I can’t think of a more cautionary tale than the Four Horsemen of the Apocalypse. They go in order of conquest, first carrying a white flag and promising peace — next, the red flag symbolizing the blood of constant warfare. Then a black flag, a symbol of mourning for the famine, which ensues when men pursue endless wars and conquests instead of managing the crops at home, and finally a grey-green, the color of death. To me, these symbols were to warn us of what might happen if we seek fame and fortune (conquest) and neglect what is essential (crops, livestock, home, even family). There is another way of saying this. Focus on what is important and focus on what you can control.
So, what does this have to do with creating a rock-solid balance sheet and setting yourself up for financial independence, and what are the Four Horsemen of Financial Planning? We will take them in order with the associated risks of each.
The challenge here is to create a sufficient cash flow to maintain your standard of living indefinitely. Inflation chips away at the buying power of your nest egg. Fail to account for inflation, and you risk not keeping up with your spending needs. There is a guideline in financial planning that you can safely withdraw 4% of your portfolio every year and keep the risk of outliving your money reasonably low.
Why such a low number? $100,000 needed in your first year of financial independence will be $103,000 the next, $106,090 the year after that, and so on. So, if you anticipate averaging 7% per year and that inflation will be 3%, you have 4%. The math is rough, but it helps explain why if you earn 8% in your first year of retirement, you can’t take the complete 8% out of your account.
Inflation is the slow erosion of buying power. You don’t notice it at first, but it can have a dramatic effect over a long period of retirement. We see the impact of inflation frequently underestimated and its impact not brought to the forefront.
It’s not fun telling clients they can only count on withdrawing 4%, but it is a hard truth. The challenging math is why we are not big fans of online calculators that let you make your assumptions. Make the wrong inputs and multiply that over many decades, and you have a significant shortfall.
Next month, we will discuss the other three obstacles you need to factor in for predictable financial independence, but I will give you a preview here. They are:
Sequence of Returns
We will talk about each over the coming months. Hope this is helpful, and we hope that if you have questions, you will reach out to use by phone or email. You can schedule a meeting with us when it is convenient for you at https://calendly.com/david-hicok