“With a Monte Carlo simulation, you’re projecting outward and analyzing what happens with the plan, but you’re also making assumptions about what the returns will be,” said Pittman. “You’re assuming that an investment strategy will remain static. With a funding ratio, you’re not making any assumptions about what will happen in the future, you’re using current and prevailing interest rates to discount anything.”
As with Monte Carlo simulations, the personal funded ratio is only as good as the information an advisor feeds into it, but the ratio creates a context for advisors to discuss asset allocation, saving and spending with clients.
Using a personal funded ratio also gives advisors a tool that doesn’t assume an indefinite planning horizon for clients, said Pittman. Theoretically, the ratio could be expanded to consider the lifetime assets and expenses for a married couple or a family across generations using actuarial assumptions for longevity, health, inflation and interest rates.
“We notice that you have a lot of trouble getting specifics out of clients,” said Hill. “At least in the context of the ratio, you can have fearless conversations—earless meaning unpleasant, and unpleasant meaning that the conversations actually mean something to the client.” One example, he said, would be convincing them that a lifestyle change might be necessary for a successful retirement.
Wealth managers have done similar work for clients in the past to show clients whether they were financially independent, or whether they would have enough money to fund their retirement and leave behind money for their family as part of their estate, Hill said.
Halbert Hargrove also uses the personal funded ratio to determine whether an annuity is in a client’s best interest, said Hill.
“Our clients in general don’t like annuities,” Hill said. “Many know that there’s a lot of academic work that says they should have annuities, but they still don’t like them.”
However, such products should be considered for some clients, says Schultz.
“An annuity has one job description: to provide you guaranteed income that you can never outlive,” says Shultz. “The academic studies offer a compelling argument that if you use a portion of your retirement assets in annuities, you inevitably end up with greater longevity of assets.”