If you’ve never encountered the term “decumulation,” you’re probably asking, “Decumu-what???”
For most of your investing life, you’ve been focused on accumulation investing, building wealth over time by maximizing your investment returns for a given level of risk. You’ve had the luxury of longer time horizons and the ability to weather the consequences of short-term volatility. Detached from spending goals, your portfolio could grow undisturbed, maybe even on autopilot as the years passed.
As you approach retirement, I need you to hear me on this: An accumulation mindset will not be ideal once you’re on the other side of full-time work.
What is Decumulation?
Decumulation is the process of spending down the assets that you’ve worked so hard to accrue over your lifetime. Think of your investments like an orchard. Your life until now has been focused on tending the trees so that they produce the most delicious fruit possible. Now it’s time to harvest those apples; you need tools and strategies different from those you employed in the growing phase.
An effective decumulation strategy must:
- Focus on outcomes.
- Account for multiple time horizons.
- Create a plan for drawing down assets.
Outcomes vs. Ideal Returns
Retirement planning generally starts as an attempt to solve a mathematical formula, and we often forget to evaluate life outcomes. Real-life consequences are more important than statistical models. As you shift into a decumulation mindset, center your decisions on creating the right outcomes for you, not the choices that may lead to optimal returns on your investments. Particularly for investments you’ll require in the near term, the return of your money is far more critical than the returns on your money (more on that in a moment).
A few years ago, I had a client diagnosed with a heart condition. Mathematically, most people benefit from waiting until Full Retirement Age to take Social Security. However, my client, we’ll call him Sam, didn’t think he would live that long. He wanted to take his benefit as soon as possible to use the funds and enjoy good health while it lasted. He passed away recently in his early seventies. Sam created wonderful memories with his family, especially his grandchildren because he’d chosen to use his resources for experiences, not stockpile them for ideal returns.
Invest for Multiple Time Horizons
Listeners of my podcast, The Retirement Answer Man, will recognize this rule as the guiding principle for my signature “pie-cake” investment strategy. During the accumulation years, most investors treat their portfolios as one large allocation pie chart that will be invested for an extended period. In retirement, a thoughtful decumulation plan recognizes that for your near-term needs, the return of your money is paramount (told you we’d circle back). However, you still need to manage the risk of inflation or outliving your money, so it doesn’t make sense to move everything to cash. It’s important that you allocate your portfolio accordingly so you end up with a few layers of pie charts (a.k.a. the pie-cake). Knowing the purpose (and, thus, the timeframe) of your accounts will help you tremendously as you make investing decisions.
Create a Spending Plan
During the accumulation years, diligent investors often sock money away without specific thought about the purpose of those funds, or if they do think about purpose, it’s broadly labeled as “retirement.” Once you have envisioned your goals in retirement, identifying the purpose of each investment and how it will help you reach your goals is essential to gaining confidence in your plan. Which account will create your near-term “paycheck”? Which accounts are “fun money” that can be used for travel? Which account will act as an emergency fund for unexpected home expenses or health bills? Identifying your intentions for each investment will help you create a thoughtful plan for spending down those assets and allow you to feel comfortable spending on life experiences, especially in the early retirement years when spending on travel and memory-making may be higher than subsequent years.
I recently spoke with Rock Retirement Club member Karen on The Retirement Answer Man podcast. Before she joined RRC, she followed the traditional approach of living only on investment interest (I’ve talked before about the limitations of investment rules like these). She hadn’t entertained the thought of setting aside cash to fund the early years of her retirement, much less considered withdrawing from the principal in her accounts. As a result, her life was comfortable but small.
Shortly after joining RRC, Karen spoke with me about a degenerative eye disease that ran in her family. Her sister had just been diagnosed with the disease. Karen, who had always dreamed of traveling the world, was aware of the risks to her own vision. Our conversation helped her realize that it was okay to use some of her retirement assets to travel and enjoy life experiences while she was still healthy and young enough to enjoy them. Understanding the mechanics of decumulation gave her the confidence to invest in her life.
I’ve been a practicing financial planner for over thirty years. In that time, I’ve seen many people leave life on the table, forgoing experiences and memories because they don’t understand how to decumulate their assets. On the flip side, I’ve seen folks continue to invest like they are accumulating, taking on much more risk than necessary, and being forced to live a more meager retirement after suffering losses. I don’t want either of those options for you! If you’re nearing or in early retirement, it’s essential that you know your plan for decumulating your portfolio. Your life is happening now! Don’t wait.
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