Saving, Investing, and Personal Finance – Death Spiral or Ascending Helix
What can you do now to reduce your post retirement risks? What is the Death Spiral or Ascending Helix? Answering those questions can help you put your financial life under your control, but it will take time and patience. It all starts with understanding your fate is up to you. This is the one of a series of articles for those new to saving, investing, and personal finance.
In planning for the financial future, you need to decide what you will need later, in order to work backward to determine how much you need to save now to reach that goal. Two of the things you have to consider is what will provide your income after retirement and what risks you are willing to take after retirement.
There are many types of plans. We will cover three types of plans in this article, they are growth plans, draw down plans, and protected principal plans.
Growth plans assume you will be able to cash out investments to provide whenever income is needed at a good return. It makes perfect sense to keep a portion of assets in growth. It might not make sense to count on continued growth to exclusively fund income after retirement. If you don't get the growth you expect, or are forced to sell, you're at the mercy of the market. That is why relying on growth alone to exclusively fund income after retirement is not generally recommended.
Many advisors recommend shifting some assets from growth to income investments as we age. Both draw down plans, and protected principal plans, are types of income investing plans.
Draw down plans let you retire with less principal but with increased risk because you will draw down principal to supplement your interest income. Your annual income consists both of interest, and drawing down principal. Several versions draw down principal and reinvest the interest to make the principal last longer. Drawing down principal is a Death Spiral because resources are depleting, leaving less and less principal to generate income in the next annual cycle. What if you plan for 20 years of withdrawals but live for 30 years, or encounter some large expense? It is possible to outlive your savings.
- Increasing interest rates may not help. An increase in rates has to more than offset the reduction in principal in order to break even or generate more income.
- If interest rates fall, then income will fall as well. Even more principal will need to be drawn down, with this cycle leading to an even a smaller principal base to generate interest in subsequent cycles.
I call protected principal plans Ascending Helix plans as a mnemonic. Ascending Helix plans allow you to increase income, while reducing risk and increasing principal. Ascending Helix plans never withdraw principal, only partial interest is drawn. Some of the interest is retained and added to the principal. This additional principal can increase interest income for the next cycle.
- If interest rates are constant or increasing you get even larger growth.
- If interest rates fall, the decrease in interest rate is mitigated by the prior growth in principal.
- There is less risk because you can thrive under a wide range of interest rates, and survive under an even greater range of interest rates. That requires a bigger nest egg initially but is way safer once set up because instead of drawing down, Ascending Helix plans build up.
Let's look at some examples. Let's assume you want to consume the 2010 median US household income of $50,000 annually, and to be conservative, let's assume the interest rates are 3 percent. For simplicity, let's assume there is only one investment, at one rate, with no taxes.
In the draw down plan, you might begin retirement with $700,000 with a 20 year withdrawal rate.
- The first year your $700,000 principal generates $21,000 so you have to supplement the interest income with $29,000 from your principal to reach $50,000 in annual income. That $29,000 reduces your principal for the next cycle, leading to less interest income. This is the Death Spiral in action.
- By the 19th year, you only have $20,981 principal remaining which generates $629. That is your annual income, less than half of your planned amount of $50,000.
- When the money is gone in year 20, there is no more principal to generate interest or to draw down. You are broke. Starting with more principal reduces the risk, but the point of the draw down plan is to draw down principal, so there will always be a reduction in principal over time.
Let's contrast that with the Ascending Helix plan which requires more initial principal but entails less risk.
- The first year your $1,800,000 principal generates $54,000 in interest so you have $4,000 remaining above your $50,000 in annual income. That means you can add $4,000 into to your principal.
- The 19th year your $1,893,658 principal has grown to $93,658 more than you started with, even though you've been living off the interest. It generates $56,810 in interest, so you have $6,810 remaining above your $50,000 in annual income. That means you can add $6,810 into to your principal.
- You could encounter a $93,658 problem, and you're back where you started. If interest rates decline the additional $93,658 principal mitigates the decline. Even a $1,193,658 problem would only lower you to $700,000 which is where the draw down plan started!
Think about those numbers! It takes $700,000 vs. $1,800,000 but there is a significant reduction in risk. That is why it is important to prepare now by saving, and investing. Events such as layoffs or injuries can force your situation, and can happen at any time.
If you keep adding to a realistic goal, you will probably eventually reach that goal. Sometimes life events will interfere and you will have a discrepancy or need to change plans. Simply use the facts at hand to make the best plan you can create with the resources you have available going forward.
Do you prefer the Growth, Death Spiral, or Ascending Helix? The choice is up to you. Planning and risk reduction are proven personal finance tools; they are two of many steps in getting to a better point in financial life. It all starts with understanding your fate is up to you.
Individual Initiative is not an investment service. The information provided is intended to assist you by providing one of many sets of ideas about savings, investing, and personal finance. You should consult many resources to gather many ideas, then use only the ones that you believe will work best for your specific situation. This website contains a comment area. Comments made are those of the contributor and may not reflect the views of Individual Initiative. All investments include risk, including loss of principal. You should be certain you understand both the risks and benefits of any investment or investment strategy before investing.