FREE NEWSLETTER
Some people are enamored with the word tariffs. My new favorite word is assumptions.
I was listening to a podcast today and they told a story of a person who went to two financial planners seeking to determine if his retirement plan was sufficient. The first planner told him he had a 95% chance of success. The second said 75%. Naturally, he went with the first planner, but failed to ask the key question. What assumptions were used in the calculation?
There are so many assumptions to consider – spending levels and patterns, life expectancy, inflation over 30 years or so, risk tolerance, a legacy goal and then there is the biggy, investment returns and the variables within that investment mix and more.
I never had to deal with this, but it sounds scary while extremely important. As the podcast noted, even a 1% difference in investment return assumptions can make a significant difference in the projection – and the income reality in the future.
Turns out in the example which enticed the individual, the 95% success, used aggressive investment return percentages with little deviation. Nevertheless, the – likely unrealistic 95% – was too enticing.
I was surprised to learn from the planners on the podcast that hardly anyone asked about the assumptions used when they presented a client with a plan.
I doubt I would know all the questions to ask, but I know using conservative assumptions would lower my stress even if it meant working a little longer.
How about you? Do you know the assumptions your future is based upon?
As a financial planner that has prepared hundreds of retirement projections for clients, this article is spot on. However, Dick fails to mention one important source of assumptions, the clients’ assumptions. One of the planners responsibilities is to bring up the assumptions the clients forget, such as home maintenance, auto replacement costs, medical costs, etc. Yes, the investment return and volatility assumptions are hugely important, and we always erred on the conservative side on both. It’s also important to point out to the client that assuming relatively minor reductions in future expenses can result in significant increases in the success of their strategy. The planner should tell the client there are no guarantees in their future,and this is simply a reasonable roadmap and invariably will require some adjustments (both positive and negative) as events develop.
The main objective of a properly done retirement plan is to either put the client’s mind at ease that they are well prepared for retirement or convince a totally unrealistic client that they are headed for disaster, as their assets cannot possibly accomplish their goals.
Although not the focus of Dick’s article, a properly done Social Security analysis, especially for a couple, is a huge part of a retirement plan.
Retirement helped me see this more clearly: “…relatively minor reductions in future expenses can result in significant increases in the success of their strategy.” Yet another form of compounding which puts time to work for you.
I understand your point. A few years ago I was doing estate planning and wanted to set aside funds so our children could keep our vacation home. The lawyer asked what we spend a year on the house. I threw out a number and she immediately said “I doubt it.” She was right, I was off by a factor of three.
numbers are ‘juked’ to produce an outcome, to provide a desired result…
in the case of the 95% there was emphasis on producing attention, to attract money, and could be rationalized after the fact to excuse variation from obvious reality (ex: it was biden’s economy–i am not culpable)
the 75% was trying to be rational and escape the inevitable disappointment of irrational expectations, assuming there IS disappointment, we seem to have the deep-dive memories of drunken gerbils these days. i’m not convinced it matters, the sources leading to that disappointment can be confused, obfuscated… (who could have predicted X??)
both camps are using the same data coming to different conclusions…
worrying about materials and methods to come to financial conclusions is to me less convincing then what they are trying to do!! quo bono, que bene? what are they trying to do?
then realize the locked door room puzzle with a can of beans for the hungry economist says ‘assume a can opener..’
Some of these planning models do not disclose all of the assumptions they use, which makes them untrustworthy IMO. These planning models are like black boxes.
I have used spreadsheets with variables like inflation, rate of return, etc; and rows for each year I am planning. The variables can be easily adjusted to see how that matters. I did this when planning my retirement, and they were very helpful. It worked better for me because I knew what my assumptions were and the calculations that were being made. I do not like black boxes.
My future is based on assumptions that change depending on the tariffs that will be imposed and of course their effect on the stock market. 25% on aluminum, 200% on European wine, 100% on Canadian lumber, 150% on SHEIN imports. Thank god for Microsoft Excel.
just kidding of course but without getting political what possible benefit can come from from all this?
I can’t imagine planning without making or knowing assumptions. You have led me to recall my first attempt at financial assumptions, made decades ago on a spreadsheet without benefit of the internet, retirement calculators, or advisors. Though overly simplistic, they guided how I saved and enabled me to estimate a future retirement date.
What were those early assumptions? First, I assumed that my then wage, adjusted by an annual inflation rate of 5% and projected forward, would still be livable at retirement age. Also being ultra cautious, I assumed no future Social Security or pension income. Other assumptions were a 2.5% draw in retirement and a 2% return on investments over inflation. Just five columns then: age, projected wages, annual savings, accumulated savings, and the accumulations-based draw. The row in which the projected draw exceeded projected wages predicted when I could retire. It also provided an estimate of how big my nest egg would need to be. I revised the spreadsheet periodically with actual savings and invested amounts, though doing so became less important once I could see I was meeting my goals. Looking back, I had a good road map.
YES
But with regard to projections I’m more interested in the range of results driven by standard deviation than the average result driven by an assumption.
The way I understand it, the deviation is built into software so I think it is an assumption.