slides_lesson 17 slides

7/28/2019 Slides_Lesson 17 Slides

1/12

Forecastingthefuture infinancialtermsrequiresmakingreasonableassumptions.

ThissecondvideoinDoingtheMathwillhelpyoudeterminethevaluesthatyoumight

choosetouse.Thereisnoperfectsetofchoices,youonlyhavetolivewiththeonesthat

youmake.


2/12

When forecastingfutureevents,theadvisorslamentoverpastperformanceisnoindication

offutureoutcomes.

Unfortunatelythereislittleelsetogoonexceptwhathashappenedinthepast. Still,there

aretwoproblemswithusingpastdataforfinancialplanning.Thehistoryofthedataisnot

thatlong

and

the

well

recorded

data

only

goes

back

about

100

years.

Also,

keep

in

mind

thatactionstakenbythegovernmentinresponsetoshorttermproblemsimpactthe

longertermoutcomes.

Giventhisconundrumitisstillnecessarytomakepredictionsinordertosetinplace

reasonableplans.Withthisinmindwearegoingtodiscussmakingreasonable

assumptionsaboutInflation,Rateofreturn,LifeExpectancyandSafeWithdrawalRate.


3/12

Thischartshowsthehistoryof inflationintheUnitedstatesasrepresentedbythe

ConsumerPriceIndex.Asyoucansee,itisfairlystableoverthelastseveralyears. Ifyou

werelookingtopredictinflationforthenext40years.Youmightchoose:

Theaverageoverthelast98years 3.22%

Theaverageofthelast40years 4.3%

Theaverageofthelast20years 2.39%

Orsomeothermeasure.

Ifyouwereforecastingtheamountthatyouneedtosaveinordertoretire,theaveragefor

40years(4.3%)wouldbeaconservativeestimate.Theaverageforthelast20years(2.39%)

wouldbeoptimistic.

Ontheotherhand,ifyouwereforecastingyourincome,the40yearaveragewouldbeoptimisticandthe20yearaveragewouldbepessimistic.

Inyourownworkyouwillhavetomakeyourownchoices. Sinceyouonlygetonelifeto

testyourassumptionsthereisareasonableargumenttobemadefortheconservative

choice.


4/12

TheConsumerPriceIndexisthemostpopularstatementofinflationintheUnitedStates.

ItsusedbythegovernmenttoadjusteverythingfromemployeesalariestoSocialSecurity

Benefitstotaxratetables.

Manyplannerscondemnitforbeingtoohighortoolowbasedonitsacademic

shortcomings.

Inmakingyourowncalculationsyouwillhavetomakeupyourownmind.


5/12

Ratesofreturnoninvestmentsareevenmorevolatile thatinflationandmoreconfusing.ThistabledescribestheaverageratesofreturnforvariousrunningperiodsintheU.S.Stockmarkethistoryfrom1928thought2008.Asareminderthestandarddeviationisameasureofthevolatilityoftherateofreturnovertheperiod.

Therearethreeunseenproblemsintransferringthisdata.Firstthesearetheresultoftheunmanaged

indices

and

there

is

survivors

bias.

Thus,

if

used

with

an

advisor

or

with

mutual

fundsyoucanprobablyexpectreturnstobeontheorderof1%lower.

Second,astandarddeviationof2.5%across15yearsisatremendousdifference.Witha50%Stock 50%Bondportfoliothedifferencebetweenbeingonestandarddeviationlowandonestandarddeviationhighistwiceasmuchmoney.Itsthereforeimperativethatyoutakeaconservativeapproachifyouwantahighdegreeofsuccess.

Third,thehighstandarddeviationinthehighstockportfolioattheshortertimeframesisacluethatusinghighequityinvestmentsforshorttermgoalsisariskyproposition.


6/12

Selectingarateofreturn putsyouonthehornsofadilemma.ThecurrentFinancialPlanner

thinkingistotakeacontrarianapproach.IftheMarkethasbeeninacyclicuptrend,be

conservative.IftheMarkethasbeeninadowntrend,bealittleaggressive.


7/12

Inretirement,planning howlongareyougoingtoliveisacriticalquestionintryingtoassessyourretirementneeds.

Lifeexpectancyisgenerallymeasuredinyearsfromyourcurrentage.Themosttypicalmeasureismedianlifeexpectancyor50Th percentile.Thatisthenumberofyearsduringwhichhalfofthepeopleyouragewilldie.

Obviouslythisisaspeculativechoiceanalysisandtherearemanysuchtablesaround. Thelifeexpectancytableusedforcalculatingrequiredwithdrawalsfromretirementaccountsindicatesthatthelifeexpectancyforapersonborntodayis82.4years. Thisisnotalinearrelationshipbecausethelifeexpectancyofapersonage1is81.6. Thushalfofthepeopleborntodayareexpectedtoliveuntiltheyare82.4 andhalfofthepeoplebornayearagoareexpectedtoliveto82.6. Whyisthis? Theobviousansweristhatthepeoplewhodiedbetweenbirthandage1arenotcountedinthesecondset.Inotherwords,peoplewhoarealready85haveabetterchanceofreaching86thanthepeoplewhoare70.

Inthinkingaboutlifeexpectancy,youwouldwanttobesurethatyouhaveenoughmoney

to

last

until

a

pretty

old

age.

Expressed

as

a

percentile,

you

might

want

to

be

sure

that

you

wouldhaveenoughmoneytolivetotheagethatyoumightexceedonly10%ofthetime.Othersmightwanttobemoresuretheyhaveenoughmoneyandthusselectahigherpercentile,perhapsthefifthpercentile. Anoptimisticpersonmightwanttolookatthe25percentile.


8/12

JointLifeExpectancyisthenumber ofyearsuntilthelastofacoupleisexpectedtodie.Its

alwayshigherthanthelifeexpectancyofeither.


9/12

Here weseetheeffectofJointLifeExpectancy.Whereastheindividualsareexpectedto

livewellintotheir80s,theresagoodchancethatonewillliveuntil90.

Theabovetablewasconstructedbasedonmedianlifeexpectancyandbeforetakinginto

considerationanyonesparticularlylonglivedfamilyhistory.


10/12

Safe WithdrawalRateisthepercentageofassetsthatcanbewithdrawnfromaretirement

accountduringthefirstyearofretirement.Itcanbeincreasedbyinflationeachyearof

retirementwithahighdegreeofcertaintythattherewillbeenoughtolastthroughout

retirement.

Thisis

asimplified

way

of

evaluating

retirement

in

agoal

based

plan.

It

presumes

that

needwillbeaconstantlytrendingvaluewithnostepfunctionstoworryabout.

Ifyoudividetheneedforretirementspendingbythesafewithdrawalrateyougetthe

amountofmoneythatyouneedtoaccumulateforretirement.

Rangeofoutcomesfromtheresearchputsthevaluebetween4.1%and5.5%. Whilethis

seemslikeasmallrange,considerapersonwitha$60,000need.

Assumingasafewithdrawalrateof4.25%theywouldneed$1.46million.

Assumingasafewithdrawalrateof5.5% theywouldneed$1.09million.


11/12

Themostsignificantdifferencebetween thevariouspapersseemstobetheamountof

interventionproposedintheannualincreaseofthewithdrawal.

Ifyouwanttobeabletosticktotheinflationpercentageincreaseregardlessofhowthe

worldmaychange,thenyouneedtobeclosertothe4.25%.

Ifyourepreparedtoadjustyourlifestyletofitthecircumstances,thentakinglesswhen

returnsarelowandrefrainingfromtheopportunitytomakeupwhenmarketsaregood,

thenyoucanconsiderchoicestowardsthetopoftherange.

Thereisnoguaranteethattheoneyouchoosewillwork.


12/12

Whileitsallwellandgoodtomakeconservative choicesabouttheassumptionsin

planningforretirement,itneedstoberememberedthateverydollarsavedforretirement

needstocomeoutoftodaysspending.

Thusfollowingaplanwithultraconservativeassumptionsmeansdenialofcurrentwantsor

evenneeds

today.

The

effects

of

conservative

assumptions

in

multiple

variables

is

a

geometric,asillustratedinthistable.

Letsconsiderthata35yearoldisstartingtosaveforretirementandthathewantsto

retireat65.Howmuchdoesheneedtosaveeachyeargivenconservativeassumptionsfor

allvariablesversusaslightlyaggressiveset? Ifyouarethinkingthatheneedsmorethan

twiceasmuchperyear,youwouldbecorrect!

Ultimatelyaplanmustbereasonableandachievableoryouwillhavetochangeyourgoals.

Inthiscaseitwouldbewhentoretireorhowmuchtospendinretirement.

slides_lesson 17 slides

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