Let’s get a few ideas out into the open immediately — ideas that are at odds with most generally agree- upon principles of financial planning and of portfolio management.
First, when your clients retire, they will need less capital than you may have been telling them.
Second, their annual income needs will fluctuate along with their personal situation, with the economy, with age and with health.
Third, they may live longer than you think.
Fourth, recognize that financial models used to design portfolios are cartoons. Follow them at your peril.
Fifth, the key assumption of most retirement planning tools — a 4 percent rate of return — is a target designed in the laboratory of academia. It bears no relationship to the real world. It is an artificial construct, a shibboleth. Ignore it.
Sixth, challenges that your client faces are strategically and tactically different from those a portfolio manager faces.
Seventh, simple approaches to retirement issues are fine, just fine.
Eighth, we need to listen to our heads, hearts and stomachs during retirement, in no particular order. Each will have its time to prevail and its time for quiet.
These eight challenges are presented as opportunities to the client. Take full advantage of these ennobling and enriching ideas. They will not only free your client to enjoy a comfortable retirement, they will also free you from the rigorous application of silly rules that have no relationship to the real world.
These ideas are presented as challenges to the investment community. A gauntlet has been thrown down, Mr. or Mrs. Trusted Advisor, who puts everyone into the same grab bag of asset-allocated mutual funds, who tells your clients to invest for the long run, who believes in the efficient market hypothesis. Step into the arena. Academics please join in. The simplicity of the ideas presented here should lead to extreme contest.
Let’s examine the first five challenges in detail. When you, the trusted financial professional, write a financial plan for a retiring client, you ask the client for their current expenses. You then plug these into the financial planning model. But financial planning models are just that: models — models with several problems:
- They are based upon “facts” that are, in reality, guesses.
- The plans are, at best, relatively static.
- They may overestimate living expenses.
- They may underestimate life expectancy.
- Their validity depends upon formulas and starting premises.
- They are not reflexive.
They are guesses, approximations or intimations. Models are neither accurate descriptions of reality nor are they fantasies (unless the input data is false). They are based upon certain mathematical formulas coupled with the client’s data. The more accurate a client estimates current expenses, the better the model can function. Yet, who would look at their expenses of 20 years ago, project them out to today and find that they bear any resemblance to their current cost of living? Models simply cannot reflect the world we know.
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