Reality check needed

FINANCIAL PLANNING: YOU NEED TO CONSIDER A WORST-CASE SCENARIO

What if future returns are well below that of the past and we live much longer than expected?

and know how the strategy is meant to play out, they’re more able to stick to it.

However, the fundamental problem with any financial plan is that it must make assumptions. To predict whether you’re likely to reach your goals, you must factor in things you can’t know for certain.

Assumption No 1

What kind of returns is an investor likely to see over their lifetime? Can an advisor use historical performance as a guide to what their clients can expect in the future?

Even in developed markets, analysts and economists are predicting future returns for stocks and bonds to below historical averages. We seem to be moving in to a lower return environment.

So what are advisors plugging into their models as the expected return over the next five or 10 years from a diversified, multiasset portfolio? Should it be inflation plus 5%, as investors would have anticipated, and received, in the past, or must that figure be adjusted? Only a few top-perfoming local multi-asset high equity funds have delivered that over the last three years. The average return for investors has been more in the range of inflation plus 1% or 2%.

Assumption No 2

How long are you likely to live after retirement? A ripe old age may now be 120. If you retire at 65, can you really afford to live off your savings for another 55 years? For how much of that period would you still be healthy enough to be reasonably independent? What would the medical bills of a 110-year-old look like?

The reality

These are all questions to which we can’t know the answers and that’s true of even the best financial plan. We have to plan for a future that looks something like the past, because we don’t have any other reference point.

However, we must consider what our back-up is if we hit a worst-case scenario that we can anticipate – that future returns are well below what we’ve seen in the past, and we live much longer than we expect.

If things really don’t work out, what does your support system look like, where and how could you live on much less than you anticipated, and what skills might you be able to use to prolong your earning ability beyond official retirement?

Involve your family, understand what people are prepared to do for you, and what they aren’t. It will make it much easier to handle if the worst-case scenario actually plays out.

We have to plan for a future that looks something like the past.