slides_lesson 17 slides
TRANSCRIPT
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7/28/2019 Slides_Lesson 17 Slides
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Forecastingthefuture infinancialtermsrequiresmakingreasonableassumptions.
ThissecondvideoinDoingtheMathwillhelpyoudeterminethevaluesthatyoumight
choosetouse.Thereisnoperfectsetofchoices,youonlyhavetolivewiththeonesthat
youmake.
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When forecastingfutureevents,theadvisorslamentoverpastperformanceisnoindication
offutureoutcomes.
Unfortunatelythereislittleelsetogoonexceptwhathashappenedinthepast. Still,there
aretwoproblemswithusingpastdataforfinancialplanning.Thehistoryofthedataisnot
thatlong
and
the
well
recorded
data
only
goes
back
about
100
years.
Also,
keep
in
mind
thatactionstakenbythegovernmentinresponsetoshorttermproblemsimpactthe
longertermoutcomes.
Giventhisconundrumitisstillnecessarytomakepredictionsinordertosetinplace
reasonableplans.Withthisinmindwearegoingtodiscussmakingreasonable
assumptionsaboutInflation,Rateofreturn,LifeExpectancyandSafeWithdrawalRate.
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Thischartshowsthehistoryof inflationintheUnitedstatesasrepresentedbythe
ConsumerPriceIndex.Asyoucansee,itisfairlystableoverthelastseveralyears. Ifyou
werelookingtopredictinflationforthenext40years.Youmightchoose:
Theaverageoverthelast98years 3.22%
Theaverageofthelast40years 4.3%
Theaverageofthelast20years 2.39%
Orsomeothermeasure.
Ifyouwereforecastingtheamountthatyouneedtosaveinordertoretire,theaveragefor
40years(4.3%)wouldbeaconservativeestimate.Theaverageforthelast20years(2.39%)
wouldbeoptimistic.
Ontheotherhand,ifyouwereforecastingyourincome,the40yearaveragewouldbeoptimisticandthe20yearaveragewouldbepessimistic.
Inyourownworkyouwillhavetomakeyourownchoices. Sinceyouonlygetonelifeto
testyourassumptionsthereisareasonableargumenttobemadefortheconservative
choice.
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TheConsumerPriceIndexisthemostpopularstatementofinflationintheUnitedStates.
ItsusedbythegovernmenttoadjusteverythingfromemployeesalariestoSocialSecurity
Benefitstotaxratetables.
Manyplannerscondemnitforbeingtoohighortoolowbasedonitsacademic
shortcomings.
Inmakingyourowncalculationsyouwillhavetomakeupyourownmind.
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Ratesofreturnoninvestmentsareevenmorevolatile thatinflationandmoreconfusing.ThistabledescribestheaverageratesofreturnforvariousrunningperiodsintheU.S.Stockmarkethistoryfrom1928thought2008.Asareminderthestandarddeviationisameasureofthevolatilityoftherateofreturnovertheperiod.
Therearethreeunseenproblemsintransferringthisdata.Firstthesearetheresultoftheunmanaged
indices
and
there
is
survivors
bias.
Thus,
if
used
with
an
advisor
or
with
mutual
fundsyoucanprobablyexpectreturnstobeontheorderof1%lower.
Second,astandarddeviationof2.5%across15yearsisatremendousdifference.Witha50%Stock 50%Bondportfoliothedifferencebetweenbeingonestandarddeviationlowandonestandarddeviationhighistwiceasmuchmoney.Itsthereforeimperativethatyoutakeaconservativeapproachifyouwantahighdegreeofsuccess.
Third,thehighstandarddeviationinthehighstockportfolioattheshortertimeframesisacluethatusinghighequityinvestmentsforshorttermgoalsisariskyproposition.
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Selectingarateofreturn putsyouonthehornsofadilemma.ThecurrentFinancialPlanner
thinkingistotakeacontrarianapproach.IftheMarkethasbeeninacyclicuptrend,be
conservative.IftheMarkethasbeeninadowntrend,bealittleaggressive.
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Inretirement,planning howlongareyougoingtoliveisacriticalquestionintryingtoassessyourretirementneeds.
Lifeexpectancyisgenerallymeasuredinyearsfromyourcurrentage.Themosttypicalmeasureismedianlifeexpectancyor50Th percentile.Thatisthenumberofyearsduringwhichhalfofthepeopleyouragewilldie.
Obviouslythisisaspeculativechoiceanalysisandtherearemanysuchtablesaround. Thelifeexpectancytableusedforcalculatingrequiredwithdrawalsfromretirementaccountsindicatesthatthelifeexpectancyforapersonborntodayis82.4years. Thisisnotalinearrelationshipbecausethelifeexpectancyofapersonage1is81.6. Thushalfofthepeopleborntodayareexpectedtoliveuntiltheyare82.4 andhalfofthepeoplebornayearagoareexpectedtoliveto82.6. Whyisthis? Theobviousansweristhatthepeoplewhodiedbetweenbirthandage1arenotcountedinthesecondset.Inotherwords,peoplewhoarealready85haveabetterchanceofreaching86thanthepeoplewhoare70.
Inthinkingaboutlifeexpectancy,youwouldwanttobesurethatyouhaveenoughmoney
to
last
until
a
pretty
old
age.
Expressed
as
a
percentile,
you
might
want
to
be
sure
that
you
wouldhaveenoughmoneytolivetotheagethatyoumightexceedonly10%ofthetime.Othersmightwanttobemoresuretheyhaveenoughmoneyandthusselectahigherpercentile,perhapsthefifthpercentile. Anoptimisticpersonmightwanttolookatthe25percentile.
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JointLifeExpectancyisthenumber ofyearsuntilthelastofacoupleisexpectedtodie.Its
alwayshigherthanthelifeexpectancyofeither.
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Here weseetheeffectofJointLifeExpectancy.Whereastheindividualsareexpectedto
livewellintotheir80s,theresagoodchancethatonewillliveuntil90.
Theabovetablewasconstructedbasedonmedianlifeexpectancyandbeforetakinginto
considerationanyonesparticularlylonglivedfamilyhistory.
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Safe WithdrawalRateisthepercentageofassetsthatcanbewithdrawnfromaretirement
accountduringthefirstyearofretirement.Itcanbeincreasedbyinflationeachyearof
retirementwithahighdegreeofcertaintythattherewillbeenoughtolastthroughout
retirement.
Thisis
asimplified
way
of
evaluating
retirement
in
agoal
based
plan.
It
presumes
that
needwillbeaconstantlytrendingvaluewithnostepfunctionstoworryabout.
Ifyoudividetheneedforretirementspendingbythesafewithdrawalrateyougetthe
amountofmoneythatyouneedtoaccumulateforretirement.
Rangeofoutcomesfromtheresearchputsthevaluebetween4.1%and5.5%. Whilethis
seemslikeasmallrange,considerapersonwitha$60,000need.
Assumingasafewithdrawalrateof4.25%theywouldneed$1.46million.
Assumingasafewithdrawalrateof5.5% theywouldneed$1.09million.
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Themostsignificantdifferencebetween thevariouspapersseemstobetheamountof
interventionproposedintheannualincreaseofthewithdrawal.
Ifyouwanttobeabletosticktotheinflationpercentageincreaseregardlessofhowthe
worldmaychange,thenyouneedtobeclosertothe4.25%.
Ifyourepreparedtoadjustyourlifestyletofitthecircumstances,thentakinglesswhen
returnsarelowandrefrainingfromtheopportunitytomakeupwhenmarketsaregood,
thenyoucanconsiderchoicestowardsthetopoftherange.
Thereisnoguaranteethattheoneyouchoosewillwork.
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Whileitsallwellandgoodtomakeconservative choicesabouttheassumptionsin
planningforretirement,itneedstoberememberedthateverydollarsavedforretirement
needstocomeoutoftodaysspending.
Thusfollowingaplanwithultraconservativeassumptionsmeansdenialofcurrentwantsor
evenneeds
today.
The
effects
of
conservative
assumptions
in
multiple
variables
is
a
geometric,asillustratedinthistable.
Letsconsiderthata35yearoldisstartingtosaveforretirementandthathewantsto
retireat65.Howmuchdoesheneedtosaveeachyeargivenconservativeassumptionsfor
allvariablesversusaslightlyaggressiveset? Ifyouarethinkingthatheneedsmorethan
twiceasmuchperyear,youwouldbecorrect!
Ultimatelyaplanmustbereasonableandachievableoryouwillhavetochangeyourgoals.
Inthiscaseitwouldbewhentoretireorhowmuchtospendinretirement.