During the summer of 2001, when the U.S. stock market was beginning its long decline, a husband and wife came into my office for some advice on retirement income planning. He retired three years earlier and rolled over both a 401k and a pension buyout into an IRA.
The man was managing his own account and had a portfolio consisting of several stock mutual funds. When he retired, his IRA was worth one million dollars. During the heady markets of 1998 and 1999, his account had grown to over $1.5 million dollars. Unfortunately, it was now back down to its original value and was losing money fast.
One reason for his account’s decline was because the couple was taking $100,000 annually from the account as income. They were too young for Social Security, so his IRA account was their only source of income. When his retirement account was growing 15-20% per year, it was possible to take 10% as income while still growing the account. When the market started losing and they were still taking income of 10%, they were facing a crisis.
I began our discussion by defining their income needs. I asked if they truly needed $100,000 annual income. They both replied, “Yes.” I asked the husband if he made $100,000 per year while he was working. He said, “No,” and that he made only $85,000 annually. A little surprised, I asked why they now needed $100,000 when they lived off of $85,000 before. They responded, “We need the $100,000.”
Since they were willing to delineate their monthly expenses, I started to make a list. One of their expenses was $800 a month for the wife to play bingo. When I asked her if $800 per month for bingo was necessary, she replied that it was and she would not give it up. When we were done making the list, it was apparent they did need $100,000 of annual income.
Of course, their budget was full of pork and luxuries they didn’t enjoy while working, but they weren’t willing to compromise on their “special” needs. Finally, I agreed with them that they needed to earn 10% on their portfolio to maintain their lifestyle. The couple already knew that and wanted me to structure their portfolio so it would earn 10% annually. I politely told them their expectations were too high and they should either reconsider their income needs or find another financial advisor that would offer them higher returns.
I’m sorry to say they did not become clients, but it was probably a blessing in disguise. I didn’t know what eventually became of them, but I do know this. Over the next two and a half years, the U.S. stock market lost almost 50% of its value. So much for their 10% per year! In fact, over the last dozen years, the U.S. stock market has crashed twice, losing trillions of dollars.
The point I’m trying to make is this: having realistic expectations of future investment returns is critical to a successful investment plan. Investors get enamored with past returns or an advisor’s overly optimistic projections, and they end up taking on too much risk. This is a recipe for disaster. Markets are very unpredictable and at times very irrational. Even Alan Greenspan, the former Chairman of the Federal Reserve who warned against “irrational exuberance,” confessed that he did not anticipate the punishing stock market declines of 2001, 2002 and 2003. He never saw it coming, and neither did millions of others.
Not long after the meeting with the couple, a recently retired widower came into my office for some retirement income planning. He didn’t have a pension, but he did have Social Security and a modest IRA rollover. This man came in with no preconceived expectations, and he wanted to know what he could reasonably expect for his monthly income. We spent some time together, and I finally suggested he was only looking at about $2,000 per month.
I felt bad giving him such a small number and nervously asked how he felt. I was totally unprepared for his response. He presented a big grin and said, “All I need is enough money to pay the utility bills, buy groceries, and fill my truck up with gas to get me up to the lake. I can do all of that on $1,000 a month and you’re giving me $2,000 a month.” I thought he was going to kiss me. By the way, he’s still a client and still going up to the lake.