“There’s also a huge gap today in life expectancies for wealthier Americans versus less-wealthy Americans,” says Blanchett. “You can’t rely on these statistics that refer to all Americans in general. There’s a higher likelihood that advisors’ clients will beat the averages.”
Blanchett is still a proponent of using the 4 percent rule for retirement planning as a simplified way to present a plan proposal to clients. An average person can understand the need to save 25 times their anticipated annual expenses for retirement, he says.
Advisors can then use a Monte Carlo analysis to determine the most appropriate savings rate and portfolio allocations and create a detailed financial plan, says Blanchett, but many investors would be intimidated by the complexity of such plans—thus a 4 percent rule remains a decent, rough translation.
At Financial Advisor’s recent Inside Retirement conference in Dallas, an alternative rule of thumb was proposed by Russell Hill, chairman and CEO of Halbert Hargrove Global Advisors, and Sam Pittman, a senior researcher at Russell Investments: the personal funded ratio.
A personal funded ratio looks like an illustrated balance sheet, with a person’s total anticipated assets on the left side, and a person’s total anticipated expenses and liabilities, which Pittman referred to as “claims,” on the right. In essence, the ratio reports whether a person would be able to annuitize all their anticipated future liabilities.
“It allows you to pretty quickly and accurately assess whether a financial plan is feasible or not,” said Pittman. Plan assets would include resources like Social Security, future savings, increases in portfolio value, retirement accounts, business values and real estate values. “On the liabilities side, it’s up to the clients. If the client wants to spend $60,000 a year through retirement, but maybe they want $20,000 extra for 14 years, we would take that ratio of those assets to those needs and determine whether the plan is funded or not.”
Liabilities also include the tax liability of the client’s investment portfolios, businesses and Social Security payments.
If the ratio is more than 1.0, or 100 percent, then the client’s retirement plan is funded, and if it is under 1.0, the retirement is underfunded. Pittman says that the risk that a client can afford to take, or needs to take, within their portfolio can be determined by the difference between the client’s ratio and 1. As the personal funded ratio approaches 1, advisors should become more conservative with portfolio allocations to preserve the capital that clients have already served.
Hill argued that the personal funded ratio could be easier for advisors to use and more easily understood by clients.
Indeed, in a recent Financial Advisor article about financial jargon, the term “Monte Carol simulation” was mentioned as confusing for clients and not necessarily helpful in explaining the effectiveness of their retirement plans.