One of the services most requested from a financial planner is helping clients determine how much they need to save in order to retire comfortably.
The biggest obstacle to anticipating retirement needs is the unexpected. Unanticipated changes in portfolio returns, significant health problems, unexpectedly high inflation, longevity, the economy plunging into a multi-year recession, or other variables can greatly affect someone’s retirement nest egg. The best a planner can do is to try and take such unexpected events into consideration.
Accordingly, I like to err on the conservative side of expectations when planning for retirement. I have always assumed most planners would. I would much rather tell retired clients they can spend more than we anticipated, rather than less.
That assumption was challenged this week by one of my software providers. I was obtaining some additional training on my retirement needs analysis software. Many years ago I stopped using this company’s portfolio models because I felt they were too optimistic. For example, their most aggressive portfolio (80% stocks) estimates a 14% annual return, while their most conservative portfolio (20% stocks) estimates a 9% return. I am not so sanguine about future returns. I estimate my most aggressive portfolio at 7.5% and my most conservative at 6%.
Now, you don’t need to be a rocket scientist, or an investment advisor for that matter, to figure out that you 
can live far more lavishly on a 14% return than a 7% return. If a portfolio with a 7% return will kick out $30,000 a year, adjusted for inflation, a 14% return will net $100,000 a year, adjusted for inflation. That is a considerable difference. If clients plan their retirement lifestyle based on a 14% return, and the investment advisor is wrong and they earn 7% instead, the result is an unhappy surprise.
For that reason, I use my own estimates instead of the pre-packed assumptions that come with these sophisticated software programs. When I told the trainer that, he got surprisingly belligerent. He claimed I was not serving my clients well because they were spending less than they actually could, thereby sacrificing more than necessary in lifestyle.
The expected returns projected by the software company are based on the past history of the capital markets. They expect the future to look the same as the past. In my book, the past 35 years have been incredibly good times for the economy. I don’t want to base my retirement, or my clients’ retirement, on the assumption that the good times will continue.
The trainer and I parted, agreeing to disagree, but I was left with the distinct impression that I was unusual in disagreeing with this company’s portfolio assumptions. Apparently few of the thousand of advisors question the software projections they use to assure clients that their retirement years are safe. This is a bit troubling to me, and it should be to you.
When your advisor gives you a retirement projection, it would be wise for you to ask a few questions about the variables used to create that projection. Here is a short list of the more important variables you need to question:
• The inflation rate
• The rate of return on your investments
• The estimated date of death
• The income tax assumptions
• Investment advice and management costs.
Even the smallest variations in any of these variables can make a huge difference in how much you can spend in retirement. Questioning them can help you understand whether your investment advisor is overly optimistic. Optimism may be a great way to approach life, but it’s not such a great way to approach retirement planning.
