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Four Scenarios That Break a Financial Plan

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.

  • Loss of Income – Primarily this concern is during one’s career, causing a depletion in savings until one finds a new source of income. This risk can also be accompanied by a difficulty in replacing income at the same level as previously produced.  Loss of income could be caused by a disability which may be protected through insurance.  However, loss of income caused by economic recession is more difficult to manage.  If income loss or decrease is prolonged, often financial plans need to be adjusted.  This may cause spending curtailment or delaying retirement if some work is obtained.
  • Unexpected Expenses – Any sudden or unanticipated expense, whether health related or otherwise, can stress a financial plan. Sometimes it may simply divert funds from other discretionary uses.  In other cases, it may cause a change in lifestyle or a delay in retirement.  By definition, these are unexpected and difficult to incorporate.  It is usually prudent to allow some room for the unexpected in a financial plan.
  • Prolonged Low Real Returns – It’s important to recognize that it’s generally “real” returns (portfolio returns relative to inflation) that contribute most heavily to financial longevity. While most financial planning tools use simulated paths for potential future portfolio returns, specifically to capture sequence of return risk, they often only use a single path for inflation.  In scenarios where returns are average or perhaps even above average, when they are accompanied by very high inflation, the real return is low.  In financial planning terms, the portfolio may perform as expected or even a bit better. At the same time, however, expenses rise much faster than expected. They deplete the portfolio at a much faster rate, causing duress on financial longevity.
  • Living to an Unanticipated Age – People are living longer and longer, as science and medicine allow us to live with ailments and conditions that our parents and grandparents could not. This too can put stress on a financial plan.  Most advisors run their financial plans to an above average life expectancy or 90 or even greater.  But, what if one spouse lives to 100 or even 105 or 110?  While it may seem far-fetched, the number of people living that long has increased significantly in the last 50 years.  One way to improve the analysis of financial longevity is to incorporate mortality probabilities for each spouse.  Being able to incorporate 2nd to die probabilities, especially when they can be customized to reflect the person’s health, habits, and heredity, are particularly powerful in a financial plan.  From a practical stand point, having some guaranteed income for life is one way of protecting against the financial drains of a very long life.


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.