What would you be prepared to do to increase the probability of achieving your financial goals?
One thing we love to do most as advisers is help clients develop tangible and meaningful financial goals. Most financial goals, once defined, boil down to spending specific amounts of money in the future, often over an extended period of time. Given this, the number one thing almost every investor wants to know is, are they going to be able to achieve this?
What investors often don’t understand is that they have the ability to make decisions that can positively impact the probability their financial goals will be achieved. The following example explains this further.
Joe is 55. He’d like to retire in ten years’ time, at 65, and is planning on a 25 year retirement. He currently has $500,000 to invest, can save another $25,000 a year over the next ten years, and he’d like a balanced 50/50 portfolio. After retirement he’d like to spend $40,000 a year (on top of what he gets in superannuation) and wants to leave an estate of $200,000 in today’s dollars to his children.
Can Joe do it? Probably.
We can’t predict the future, but based on cautious expectations about future market returns, Joe has a 54% chance* of being able to achieve his investment goals.
However, Joe, like most investors, isn’t exactly thrilled at a 46% chance that his plans won’t work out exactly as he’d like them to. What should he do? This is where we get back to our opening question – what would you be prepared to do to increase the probability of achieving your financial goals?
To help Joe decide what he would be prepared to do, we looked at the likely impact of making incremental adjustments to each element of his plans. These are the levers Joe can choose to pull to orchestrate a different outcome. For example, what’s the impact if Joe saved 10% more, spent 10% less in retirement, left 10% less to his children, worked one year more, or took slightly more portfolio risk?
Each of those adjustments has a different impact on the probability of Joe reaching his financial goals.
As you can see, the two things that have by far the largest impact on Joe achieving his investment objectives are spending 10% less in retirement (+12%) and working one year longer (+11%). Some investors find it amazing that, with a 25 year planned retirement, changing it to 24 years can have such a substantial impact on the probability they achieve their goals. However, by working one more year you:
- Can make one extra year’s worth of portfolio contributions
- Aren’t taking any drawings from your portfolio during that year
If we changed Joe’s circumstances, the amount of impact these adjustments had would also change. This analysis is very sensitive to the inputs. However, the point is that the things that make the biggest impact are often not directly related to the investment portfolio, but rather, are decisions that the investor has control over.
Investors will naturally feel differently about each of these adjustments. One investor may be happy to work another year, but another may prefer to increase their level of investment risk and spend less in retirement. The role of a good adviser is to help an investor decide which trade-offs they are going to be most comfortable with, and ensure that the agreed strategy is followed.
Of course, some investors are in the fortunate position of having very little risk of outliving their money. With those investors it can be important to encourage them to spend more, or help them consider ways they might be able to pursue some philanthropic objectives during their lifetime.
In all cases, probability analysis is a critical tool.
There is no universal right or wrong set of trade-offs, but there is a right combination for each investor. An adviser can help investors make smart decisions about their money by understanding how their decisions can substantially impact the long term outcomes.
* based on detailed Monte Carlo modelling and analysis