- Consumer
Retirement Projections Errors
You’re planning your retirement and estate. Your financial planner develops a budget and plan. The budget results will determine cash
flow needs upon which investment strategies may be based. These strategies then
need to be coordinated with your overall estate, asset protection, and other
planning. Too often projections are flawed and lead to inappropriate product
sales, a false sense of security, or an overly simplistic investment plan. Many
investors are overwhelmed by 100+ page computer generated plans. The volume of
pages and charts can give the calculations an appearance of reliability:
Expense Patterns:
Your budget reflects
anticipated future expenses for which your planners then determine the best way
to generate adequate cash flows (e.g., an asset allocation model that reaches
your goals while minimizing investment risk). Expense projections may use
your current expenses as an assumption. Will
your future expenditures mimic current outlays?If not, projecting historical costs might be
meaningless. Are you planning
to downsize your current home, or instead to purchase a vacation home? The
swing in annual costs can be huge. You must evaluate your future expenses or
your planning will be based on misleading assumptions.
Inflation:
Inflation of your
expenses has to be considered. Many projections assume a 3% inflation of expenditures. 3% may be a reasonable historical average for inflation, but is it sufficient for your particular situation? If your retirement expenditures will focus on medical expenses, luxury travel, and grandchildren’s tuition, not only might these
expenditure patterns differ significantly from what you’ve spent in the past, but they might inflate at far
faster rates than the market basket of goods on which the average 3% data is based. A 1% difference in inflation rates over a 20+ year retirement can
wreak havoc with your plan. Evaluate the rate. Stress test the plan. What if
your expenditures inflate at 5% instead of 3%? If you invest solely in
muni-bonds, CDs, and other “income” investments for
“safety”, stress test your projected cash flow versus realistic
costs. Including inflation may undermine your expectations.
Gifts:
Did you budget for
gifts? You may wish, during your retirement to step up gift programs to family. This is not only done to address
estate tax, but to help children at ages when they are buying houses or
launching businesses, etc. Too often these potentially significant transfers
are ignored in the projections.
Age:
Most people tend to underestimate
their life expectancy when planning for their financial issues in retirement (a lot of people out-live “life
expectancy”), but over estimate their life
expectancy when putting off estate
planning decisions. Get realistic about
both.
Reverse Compounding:
Everyone investor knows
compound interest is the 8th wonder of the world. But when the above issues
compound over the potential decades of your future retirement the number swings are potentially devastating. Caution now may mean a pinch in
your budget. Unrealistic assumptions now might mean selling your home in 15-20
years to pay for living expenses.
Investment Allocations:
Your investment asset
allocation plan should, according to many, differentiate between taxable and
non-taxable accounts. Tax inefficient assets could be held in non-taxable
(retirement) accounts. These might include REITs (high dividends), taxable
bonds (high interest), and small cap stocks (high turnover). Tax
efficient asset classes could be held in taxable accounts. These might include
muni-bonds (tax free interest) and large cap stocks (less turnover). This
approach is too simplistic if it ignores the trusts and entities many high net
worth investors have. A bypass trust created by your late spouse for your
benefit could favor asset classes most likely to appreciate since the growth
will be outside your taxable estate. If you use grantor retained annuity trusts
(GRATs) to leverage gifts of assets out of your estate, the most volatile asset
classes could be held in such trusts since short term GRATs remove the
appreciation (upside volatility).
A budget and financial
plan can be the foundation for much of your planning. But if they’re based on
faulty assumptions, your future could be tough.