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How To Fill Your Retirement Income Gap

Nov. 22, 2013
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By Jonathan DeYoe, CPWA

Learn more about Jonathan on NerdWallet’s Ask an Advisor

In a nutshell, a financial plan is a document that balances all of a family’s current financial inputs – the income and outflow on their cash-flow statement and assets and debts on their balance sheet – with all the family’s hopes and goals. It includes a fair amount of respect for their risk-tolerance and a series of assumptions. There should be a discussion of trade-offs that goes along with the plan’s design, for instance: if you save more you can retire earlier, or, if you send the kids to an expensive private school, you have to work longer, or, if you remain in the big expensive house, you probably can’t travel as much unless you agree to work longer or spend less on some other important element of your lifestyle.

So a plan is essentially a balancing of current and future needs and wants with current and future incomes and assets. The question, “What kind of financial plan do you have?” is simply a reference to how you choose to balance the FINAL trade-off – retirement.

In most people’s plan, their last big goal (from a purely timeline perspective) is having enough assets to spin off an income that they cannot outlive. The big family vacations have been taken, the parents have been cared for, the kids have graduated from college, and the only major concern remaining is a lifetime of retirement income. This is also probably the largest of all the planned for expenses, so it is important to solve correctly for having enough. If you don’t have enough, you can’t retire either when or in the manner you had previously planned – you may have to drastically reduce your lifestyle if you are forced to retire prior to having “enough.”

Save more, or make more?
To this end there are two kinds of plans. Did you start your plan with a big return number in mind and use that return number to determine portfolio risk and therefore reduce savings requirements? OR did you allow for more conservative returns, and fill the increased gap with a higher savings rate?

For 95% of the people I have worked through the planning process with, there has been a gap between what the client has right now and what they will need over the remainder of their lives. That gap can be filled in three ways when we plan. We can increase our return assumptions, we can reduce our inflation assumptions (which is really the same things as increasing our REAL return assumptions), or we can save more. NOTE: this means savings and return have an inverse planning relationship. The higher my return expectations the less I have to save (and the better lifestyle I can live today). Or, the lower my return expectations, the more I have to save (and the less I have to spend).

Expecting too much of your advisor
Think about the tension this puts on the client – advisor relationship. A client wants higher returns so they can save less and live better today. A good advisor, knowing that market returns are not predictable or controllable in any way, will recommend more savings and reduced return expectations. If an advisor doesn’t step on this “Fill the gap with return” mentality right away and continuously, the client might eventually walk to an advisor that WILL promise to fill the gap with better returns. Note: the ability to provide has little to do with the ability to promise.

Forget that returns are not predictable or controllable. Forget that planning and behavior are the true keys to client success. Someone can always be found who, either nefarious or stupid, will promise “better returns” and if the client is not inoculated against this and ultimately decides to walk, it is to the detriment of all –none, however, more than the client.

Jonathan DeYoe, California Insurance License #0C21749, is a registered principal with and securities and advisory services offered through LPL Financial, a Registered Investment Advisor – Member FINRA/SIPC.

The opinions voiced in this material do not necessarily reflect the views of LPL Financial and are for general information only and are not intended to provide specific advice or recommendations to any individual. For your individual investing needs, please see your investment professional regarding retirement planning.