At a high level, there are 4 causes of a broken financial plan. But, first, let’s define “financial plan”. A financial plan accounts for anticipated savings and spending, incorporates assets, income sources, longevity, and yields some probability of running out of money. A sound financial plan should attempt to ensure a person’s lifespan does not outlast their resources. Ideally, a plan also allows one to maintain their lifestyle permanently. However, this isn’t categorically a requirement if anticipated decreases in spending are forecasted beforehand.
A broken financial plan sees a client’s resources completely depleted prior to end of life. These four events are the primary drivers of a broken financial plan, and advisors should be prepared to explain them…and help clients avoid them.
So, what can advisors do to reduce the chances of a broken financial plan?
Generally speaking, operating with spending and retirement plans that produce a low probability of running out of money is the safest way to reduce the chances of failure late in life. But, scrimping and saving every month and working through old age isn’t always the best plan either. We all know someone that never made it to retirement. Life is about balance. Good financial planning has to contemplate enjoying the pre-retirement years as well as being able to continue a comfortable lifestyle in retirement.
From a planning perspective, being able to measure someone’s probability of outliving their money in a reliable fashion is key. Advisors incorporating a likely evolving asset allocation (remember – today’s asset allocation might not be the best indication of what it will be in 5, 10, or 30 years), dynamic inflation scenarios along with dynamic portfolio returns, and 2nd to die mortality probabilities into a financial plan goes a long way to improve the efficacy of the results. Ultimately there is no “right” probability of running out of money. This is a very personal choice. While financial planners can offer guidance, ultimately each individual must be able to live with their own decision.
Perhaps the very best way to mitigate the chances of a broken plan is to measure and update frequently. Much like a well visit to the doctor is scheduled to catch an adverse condition or illness early – while it’s most treatable, regular financial planning is our best defense against future breakage. Examining small changes to someone’s probability of outliving their funds is the best way to course correct where needed. It is always much easier to make small revisions to one’s financial plans than be forced to make draconian changes later in life.
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