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How to Know Your Retirement Cash Flow Needs

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar. I'm here at the Investment News Retirement Income Summit, and I'm joined today by Erin Botsford. Erin is the president and CEO of the Botsford Group, a financial advisory firm. Erin, thanks so much for being here.

Erin Botsford: Thanks for having me.

Benz: So you talk a lot, Erin, about this concept of Lifestyle Driven Investing. Tell us what that means to you, and to your clients, when you're helping them to manage their portfolios.

Botsford: Well, I'd be happy to. Lifestyle Driven Investing, we come at it from a premise of, everybody starts off, when they're young and they're going to get a job, they have a dream. And the dream is to create what I call their preferred lifestyle, a preferred future.

Well, when it comes down to it, their preferred future requires cash flow. And so what we just said, we call it lifestyle. And so, every single person, what we do is we work with them and we say, OK, if you retired tomorrow and sometimes tomorrow is really 10 or 15 years from now, what does it take to sustain the lifestyle that you've worked so hard to achieve? And so there's a number there, and the interesting thing about it is it's different for every single person.

You can't really say, well, it's going to be 80% of what your existing cash flow is, because you really take it down to, how are you going to spend your time in retirement? What are you going to be doing? Do you want to take the kids on a vacation? And each person's answer to that is different.

The other thing that's different about it is that it changes. The first couple of years of retirement, maybe you're on vacation and then you're traveling, and finally, after five or six years of that, you say, I'm worn out, I don't want to do this, I want to stay at home.

Benz: Or the health isn't so good.

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Botsford: Yes, or I want to raise my grandkids, and things like that. So there's no static number. But at the end of the day, it's all about cash flow. So what we do, our Lifestyle Driven Investing is, when we come up with that number, let's say it's $100,000 a year, and maybe they do or don't have a pension, or maybe they do or don't have dividends from stock, or royalties, or alimony, or whatever it is, Social Security.

What we do is, whatever the differential is, whatever the shortfall is and we know how much do they have in all of their 401(k)s, and their CDs, and their brokerage accounts--all we do is we segregate a certain amount of money, and that money we call lifestyle investments.

And here's the criteria for a lifestyle investment. It must produce an income, either now or in the future. I want to be able to turn that income on or off. The income must have one of these words associated with it. It has to be either safe, or predictable, or guaranteed. Then I want to take those dollars, and if I can, I want to put them in some kind of a legal wrapper, or a legal structure, to give those people asset protection in case, God forbid, something happened, they were sued, they don't need those assets going away in a judgment, and now they've had the rug pulled out from underneath them.

So those are called lifestyle investments. And what that does is it really kind of locks down what they need in retirement. And anything beyond that, then we call, simply, non-lifestyle. And then they can actually be a lot more aggressive with those dollars, because they don't need it to stay in their basic lifestyle. So that's just kind of the segregation of how we manage money and how we view money.

Benz: Backing up to this income replacement question. We recently had a very active discussion on our discussion boards, on Morningstar.com, about that 80% income replacement rate. Some people saying that their real income needs were higher than what they were actually earning in retirement. Some were lower. What are some of the key factors that someone, who is planning for retirement, should keep in mind when trying to figure out how much income they'll be needing to replace?

Botsford: Well, it's very individual, as I said. And so, obviously, you have whatever costs are associated with housing. And then how you want to spend your time. Are you going to have a part-time job? Do you want to travel? What about golf? What about your leisure activities? And really, the interesting thing is, with the exception of the extra stuff, the stuff they haven't been able to do while they're retiring, a lot of the costs stay the same. While, sure, there's maybe a cost savings because they're not buying business or professional clothing anymore. Or maybe they're not driving as far, they don't have a daily commute. And maybe they can give up the one extra cell phone.

The interesting thing is, what we try and manage is, we try and manage, we have a saying, it was given to me by another person, it says, "Always make your future bigger than your past." We don't like to focus on what a client's going to give up in their retirement. We don't really think there's a big need for that. We like to say, what are you going to do with all that extra time? And we try to make it a real positive experience, instead of how are we going to do cost-cutting measures, so that you can do less instead of more.

Benz: Well, a related question, and a practical one, is how do you factor for health-care costs and how they might change as a person matures?

Botsford: Well, that's the $64 million question, that none of us can get along on [laughs]. I think it's a really, really important thing. And I think if there's one thing that came out of the current legislation, it's going to force the discussion of, how do we manage those health-care costs? A lot of people will be able to--retirees from companies--at least they're able to maintain the health-care coverage of their former employee. I think that we will resolve this as a country. I know that, right now, I have five siblings who do not have health-care coverage, so I'm very interested in the topic. Because what do people like that do?

Benz: So, for retirees, it's obviously very individual, specific.

Botsford: Sure.

Benz: Depends on what kind of health-care coverage they have.

Botsford: Sure.

Benz: But obviously you probably want to plan for some health-care inflation.

Botsford: Absolutely, a lot of health-care inflation, unfortunately. So, stay healthy and run [laughs] .

Benz: Thanks, Erin. Thanks so much for your insights.

Botsford: Oh, you're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.