When entering retirement, we are presented with a lot of what-ifs. What if I live longer than expected? What if I run out of money? What if my investment returns don’t maintain? What if I can’t have the lifestyle I want? Let us reframe this question to see how you can best prepare yourself for these situations. In this example, you are going to start selling apples at a farmer’s market.

The Apple Tree

In your yard, you have a beautiful apple tree that makes the biggest, reddest, juiciest apples that you have ever seen. You decide to sell these apples at the farmer’s market, and as a good business owner, you advertise the apples on social media. You receive 40 comments, with 10 people saying that they will be there, and 30 people saying that they will try and be there. The problem is that your tree only has 40 apples.

The day of the market comes, and your first customer arrives. What do you do? You have a decision to make. Do you only sell them only one apple in hopes that everyone shows up, but the risk is that you may have a basket of apples remaining? Or do you give them a few apples, knowing that if you get all 40 people attending, you will run out part-way through?

How Many Apples Per Year?

This is the problem we face in retirement. We don’t know how many apples we need over the course of retirement. When we start retirement, we are healthy and can take advantage of enjoying our money the most. However, if we take too many apples at the beginning of retirement, say for the first 5 or 10 years, then we run the risk of running out of apples by the 30^th year. By the time we reach the 25^th year, we must scrimp and save, and we may even have to start slicing apples because it is now a very real possibility that we will run out.

This is a fear that we all must face in retirement. We have this choice between living well and running out of money or living minimally and not being able to enjoy retirement to its fullest because of the fear of running out of money.

Making More Apples

Let us add one more layer of complexity to this matter. Let’s assume that at the beginning of the season, you bought a special fertilizer that instantly allows your tree to produce another apple each time you pick one. Because you feel confident in the fertilizer, you start selling each customer 4 apples. By the 10^th customer, your spouse shows up with even more apples and your stand is now overflowing with them. But what happens if the fertilizer did not work as it was supposed to and now your tree has stopped producing more apples? You have been giving each customer 4 apples, and now by the 30^th customer, you get the call that are no more apples growing on the tree. Now, you may have to start cutting the number of apples you sell in half because you gave away too many apples at the beginning.

This is what happens when you take on risks within your investment portfolio. Why do we take on this extra risk? We take risks so that we can get higher returns, which means that we have more money to live better in retirement. In the apple scenario, the fertilizer allows us to give away more apples at the beginning because we expect more apples to re-appear. What happens if this does not happen? This is what taking on risk means; we must accept the possibility that more apples might not appear.

First Bad Years

This sequence of returns is when the apple tree stops producing more apples and we are suddenly forced to cut apples in half or reduce our spending, as we live longer. If we get a bad sequence of returns, it means that we don’t get as many apples as we hoped to use in retirement because we got unlucky. When we invest in risky assets, we must acknowledge that we face the risk that we are going to be unlucky at some point.

We all face this dilemma in retirement. It is not only how much money can we spend year-over-year so the money does not run out, but also using up too little where there is a large lump sum leftover that we could have enjoyed. It is also about how we balance risk so that we don’t end up with negative returns, especially at the beginning of retirement when it will hurt us the most. When working with a financial advisor, there are products and investments that can be used in such a way that you can maintain your retirement lifestyle without the risk of running out. A financial advisor can also help mitigate the risk of a market downturn, which may cause your retirement dreams to fade. Talk to your financial advisor today about these options to secure your retirement and live the life you want.

I do have to give credit to Michael Fink, Ph.D. for the original cake analogy which this was adopted from.