Steady State

In systems theory, steady state means that while the specific elements in a system amy be changing, taken as a whole the system does not. For example, a process where raw material is fed into a processing machine and product is removed at the other end is in steady state because if we observe the machine it is always the same. Even though specific elements of the raw material will be different the overall machine is unchanging.

That’s how you want your retirement plan to work.

Retirement plan as steady state

While the ideal of steady state is a simple idea, the real world makes for some complication and planning helps you overcome those complications. Some of them are:

  1. The time factor. While steady state may happen in general, on an annual basis, each month is different.
  2. The inflation factor. Each year is a little different and the accumulation of the increase is important to know
  3. The taxation factor. Taxes reduce some forms of cash flow and must be considered.
  4. The investment factor. The resorvoir from which the money inputs come has a varaible rate of change. Not evey year is like another and although the range of return is predictable it may take time to smooth it out.
  5. The changing circumstance factor. People change. What they want to spend at 70 may be quite different from what they want or need to spend at 85. Some of the changes involve health and may be quite dramatic in their effect.

Techniques like budgetting and a reserve fund tend to smooth out the short periods, but something more general is needed to deal with retirement times that now approach 30 years.

Planning for longer periods

If you know there will be problems or opportunities, you can arrange your affairs to accomodate them.

Planning, at its beginning, is organized anticipating. Once you can understand how things are likely to work around the changing factors and your ability to supply resources, it becomes easier. You can see cash flow disparities. Too little is a clear sign lifestyle is consuming too much and savings must be higher. Either that or reduce lifestyle expectations in retirement.

Often early retirement income is too high and taxes take money you may need late in life. You must come to understand that income and cash flow are different. You spend cash flow to live but pay tax on income. Proper balancing them can prove useful.

Anticipating lifestyle spending and cash flow after taxes will automatically create a projection of your estate. From that you can estimate if there is enough liquidity to pay costs, make charitable bequests, and equalize amounts among the heirs.

A dynamic model allows you to test many assumptions about inflation, yield, health related costs late in life, and the effect of disposing of some asets you use now like your home or cottage.

Never trust a model to right

No model is a fact, it is just a way to get insight into a condition that covers a long time and whose outcome matters to you. Ideally it can help you discover structural problems and allow you time to makes changes to accomodate them. In many cases, parents discover they have assets they are unlikely to use in their lifetime. This observation provides them the opportunity to transfer wealth to their children earlier. The experience is people usually receive inheritances after they are 60. By then they are not especially valuable to them. Certainly not as valuable as when they have a mortgage and are saving for education for their children.

Organized predicting

Organized predicting permits a vision of retirement and an estate over decades. Decisions are more likely to work when they address the person’s context in more than one dimension.

You achieve it by preparing a net worth statement now, building a cash flow model over the time between now and age 100, projecting the estate, and then testing for the effect of yield, inflation, and new living costs. You can see where you may have choices and where you do not. You can see where you are going and find better ways to get there. And that, after all, is all there is to planning.

An example in graphic formThe ongoing surpluses indicate further research would help decide if early wealth transfers are safe and useful. That analysis would include how predictable income is. In this case, about thalf of the income is from invesstments and that could vary materially in the short run. Perhaps a review of early transfer should be addressed 5 years or so in the future.

The goal

You should address your will to see if it conforms to your wishes when costs and illiquid assets are included. Many surprises here.

Always be sure what you take out of your system is replaced elsewhere or is unneeded to a achieve your goals. Steady state.

I help people understand and manage risk and other financial issues. To help them achieve and exceed their goals, I use tax efficiencies and design advantages. The result: more security, more efficient income, larger and more liquid estates. Please be in touch if I can help you. 705-927-4770

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