The Fear of Running Out of Money Is Rational. The Way Most People Handle It Is Not.

Scott Wallschlaeger, CFP®, CEO MPPL Financial

Over the course of my career, I’ve seen the same fear sitting across the table from me in many different forms.

It might look like a 70-year-old who still can’t bring themselves to retire, even though their portfolio could comfortably support it. It might look like a 75-year-old who wants to help her grandchildren pay for college, but won’t write the check because of the thought in the back of her mind: What if I need it later? It might even look like a young couple who sold a business for life-changing money and still lie awake at night wondering whether it will be enough.

The fear of running out of money is one of the most common and powerful sources of financial stress in personal finance. In my experience, it is also one of the most misunderstood.

The Fear Is Reasonable. The Outcomes It Creates Are Not.

The fear is reasonable. Running out of money late in life would be catastrophic. But after years of sitting across the table from people with very different levels of wealth, I’ve learned that the intensity of the fear is rarely a good measure of the actual risk.

Most people who have accumulated meaningful wealth, whether through financial success, diligent saving or both are nowhere near the cliff they imagine. But many have never actually determined where the cliff is. They know what they have saved, but not whether it’s enough to support the life they want to live.

Others may have a real problem but avoid looking closely enough to do anything about it.

The fear can feel the same. The reality is very different.

The first job of financial planning is to determine which situation you’re actually in. If you’re financially secure, the question isn’t how to protect every dollar forever. It’s how to use your wealth confidently while still protecting what you truly need.

That starts with separating what you must spend from what you choose to spend.

Start by Separating What You Must Spend From What You Choose to Spend

Before discussing investment strategies, determine what you actually need to fund each year on non-discretionary items including: housing, insurance, taxes, healthcare, food and other essential expenses.

Then subtract any guaranteed sources of income you may have or expect, such as Social Security, pensions or other income promised for life.

If guaranteed income covers your essential expenses, you’ve already eliminated a significant part of your retirement risk. If it doesn’t, the shortfall needs to be addressed.

Everything else is discretionary.

And that’s important because discretionary spending doesn’t necessarily need to be guaranteed. Instead, it needs a thoughtful investment strategy and the flexibility to adjust as life and markets change.

If a genuine shortfall exists, only then should the conversation turn to how to close it.

If a Shortfall Exists, There Are Several Ways to Address It

If guaranteed income doesn’t cover essential expenses, there are several ways to address the gap. The right approach depends on three things:

1. How much certainty is needed
2. How important flexibility is 
3. Whether leaving assets to heirs matter

One way to address a shortfall is to rely on high-quality bonds. These can provide predictable interest and principal payments over defined periods, making them useful for funding known expenses. However, they aren’t necessarily a reliable source of lifetime income. Interest rates change, bonds mature and reinvestment rates are unknown. What looks like a predictable income stream today can look very different 10 or 20 years from now.

A bond portfolio can provide predictability over a defined period. However, it is much harder to make that income predictable for the rest of someone’s life.

An immediate annuity is another option, converting a portion of assets into guaranteed lifetime income. The tradeoff is less liquidity and control over the principal.

Other insurance-based strategies can provide lifetime income guarantees while retaining some access to the underlying assets, but they may come with higher costs, surrender provisions and greater complexity.

Before choosing an option, it’s important to evaluate those tradeoffs as part of the entire retirement plan, not start with a particular product and try to make the plan fit it.

Once the essential income gap has been addressed, however, there’s another question to consider: Does the rest of the portfolio need to be managed with the same emphasis on protection?

The Counterintuitive Part: Don’t Pay for the Same Protection Twice

Many people think they should get more conservative when they retire, even if they have enough guaranteed income to cover required expenses.  We don’t necessarily agree.

A guarantee is itself a form of risk management. If you’ve deliberately built enough guaranteed income to cover your essential expenses, you have already reduced one of the biggest risks in retirement: the possibility that a market decline will leave you unable to pay the bills. That can give the remainder of the portfolio a different job.

Rather than making everything conservative, we can allow a greater portion of the portfolio to remain invested for long-term growth, subject to the client’s overall circumstances and risk tolerance.

The objective isn’t to take more risk simply because a guarantee exists. It’s to avoid taking too little risk with assets that may need to support a 25- or 30-year retirement.

The guarantee is there to solve a specific problem: an income gap for essential expenses.  The rest of the portfolio doesn’t necessarily need to solve that same problem.

This becomes particularly important as inflation compounds over a long retirement. A portfolio that is too conservative may feel safe today but leave a retiree with significantly less purchasing power decades from now.

The goal isn’t to eliminate risk. It’s to take the right risks with the right dollars.

The First Few Years of Retirement Are Crucial

There is another risk that doesn’t get nearly enough attention: sequence-of-returns risk.

Essentially, the order in which investment returns occur can matter enormously in retirement. Two retirees can have identical portfolios, identical withdrawals and identical average investment returns over 30 years and end up in dramatically different places. Why? Because of when the bad years occur.

A major market decline early in retirement can be particularly damaging because you’re withdrawing money from a portfolio at the same time its value is falling. Those dollars are gone. They don’t participate in the eventual recovery.

The same market decline later in retirement may have a much smaller impact because the portfolio has had years to grow and the remaining assets have a smaller withdrawal burden relative to their value.

This is why at MPPL Financial we build clients an income funnel before retirement, not after it.

A retiree who enters retirement during a market downturn with several years of planned cash flow already funded isn’t a forced seller. An unprepared retiree may be. That distinction can have an enormous impact on long-term outcomes.

How the Income Funnel Works

Rather than making the entire portfolio more conservative, we map out several years of expected cash flow and fund those needs deliberately.

The goal is two-fold: 1) to know how much money will be needed and 2) which accounts and investments will provide it.

The first 12 months are generally held in cash or money-market investments. There is little reason to take investment risk with money you know you’ll spend within a year.

Years two and three can be funded with defined-maturity ETFs, individual bond ladders or other investments designed around specific cash-flow needs and timing.

Then comes the discipline that makes the strategy work.

When markets are strong, we can harvest gains and refill the funnel, while also accounting for larger known expenses coming in the next few years, such as a vehicle replacement, home repairs or a construction project.

When markets fall, we don’t necessarily need to sell stocks to fund living expenses. We let the funnel do its job and give the growth portfolio time to recover.

Historically, many market declines have recovered within a few years. But severe bear markets can take considerably longer, which is why a three-year funnel is not a guarantee or a rigid rule. In difficult markets, the funnel may need to be extended or other planning levers may need to be pulled.

This is also where having enough guaranteed income becomes particularly valuable.

Ideally, the income funnel represents a relatively small portion of the overall portfolio—often less than 30%—allowing the majority of assets to remain invested for long-term growth.

That matters because retirement can last 25, 30 or even 40 years.

You don’t want to solve the risk of running out of money at age 72 by creating another problem at age 92: running out of purchasing power because your portfolio didn’t grow enough to keep up with inflation.

New Retirees Need Something More

Here’s the part that experience teaches you and textbooks don’t always capture. For a brand-new retiree, even the best income funnel can’t be perfectly accurate. That’s because retirement spending isn’t perfectly predictable.

People retire with more free time than they’ve had in 40 years. Some continue living much as they did while working. Others travel more, eat out more, renovate their homes, pursue hobbies or simply discover that retirement costs more than they anticipated.

So alongside the income funnel, new retirees often need a reserve fund. This isn’t necessarily the three-to-six-month emergency fund you may have maintained during your working years, although that can act as the seed money. This is a temporary buffer for the spending that no financial plan can perfectly anticipate.

We may determine the size of that reserve based on existing spending patterns or solve for the maximum amount a client can spend while still maintaining a high probability of success. The purpose is simple: give new retirees a couple of years to discover what retirement actually costs without forcing them to sell investments during a bad market. It also prevents something equally damaging: being so afraid of spending that you fail to actually enjoy retirement.

The good news is that this reserve is often temporary.

After a couple of years, once we can compare the original plan with actual spending, the income funnel can be recalibrated. In many cases, the additional reserve becomes unnecessary beyond a true emergency fund.

We’re Not Looking for Perfection

Most of us were taught that 100% is the goal. On a test, 100% is an A. In retirement planning, it isn’t quite that simple.

Many advisors use Monte Carlo analysis as a planning tool that tests a retirement strategy against hundreds or thousands of different combinations of market returns, inflation, spending and other variables to estimate the likelihood that the plan will succeed.

A 100% Monte Carlo success rate can sound comforting to clients, but pursuing it at all costs can mean working longer, saving more or spending less than necessary. If leaving a legacy isn’t a priority, that may mean spending too much of your retirement protecting money you could have enjoyed.

An 80% Monte Carlo score doesn’t mean you’re destined to run out of money. It means the analysis suggests there is a possibility that some adjustment may eventually be needed. With annual planning, those adjustments can often be small because you can see problems developing well before they become serious.

The goal isn’t to create a plan that can never change. It’s to create a plan that can change before you have to.

The Risk People Actually Underestimate

We all understand that buying penny stocks, trading options or using margin and leverage can be risky. Those kinds of bets, if someone chooses to make them at all, should generally be limited to money they can afford to lose.

But there is another risk we consistently see in our work that people underestimate: Concentration.

Sometimes that means having too much of an investment portfolio in one company or a handful of companies. Sometimes it means having the vast majority of your net worth tied up in your own business.

Concentration can feel safe when the companies involved are large, successful and admired. But great companies don’t remain great forever. Businesses change. Competitors emerge. Leadership changes. Industries evolve. A single mistake can permanently alter a company’s trajectory.

Diversification isn’t exciting. That’s exactly why it works.

For most retirees, the return required to support a successful retirement does not require taking heroic investment risks. A well-constructed, diversified portfolio can provide a reasonable path toward the returns necessary to support long-term spending.

The problem is that building and maintaining that portfolio takes work.

Thoroughly researching dozens of individual companies and continuously updating that research is not a part-time job. This is one reason we believe strongly in having a dedicated investment team.

Managing a retirement portfolio isn’t just about picking investments. It’s about managing risk across the entire financial life of a client. And that requires time, discipline and a process.

The Answer to the Biggest Fear

The people who ultimately run out of money are almost never the people who spent their entire retirement worrying about it. They are often the people who looked the other way.

There is no single financial product that solves the fear of running out of money. There is no single investment strategy, probability analysis, or conversation that makes that fear disappear permanently.

What works is much less exciting, and in my opinion much more effective.

• Ongoing financial planning.
• A deliberate structure for the money you need in the near term.
• A diversified investment portfolio designed for long-term growth.
• Professional investment management.
• And the willingness to make small changes early when needed, rather than drastic changes late.

The goal isn’t to eliminate uncertainty. Retirement is too long, markets are too unpredictable and life is too complicated for that. The goal is to make the risk proportionate to reality.

Because for most people, the greatest financial mistake isn’t spending too much. It is spending too many years protecting a number they have already saved enough to enjoy.

The fear of running out of money is rational. However, once the plan shows you that you’re safe, the next job isn’t to protect your money forever.

It’s to start living.

No client or potential client should assume that any information presented or made available on or through this article should be construed as personalized financial planning or investment advice. Personalized financial planning and investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Please consult legal or tax professionals for specific information regarding your individual situation. Insurance products offered or sold are paid commission.

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