What are we missing in our assumptions around planning, our practices and the future? What important out-of-the-box issues aren't you hearing about in the press and at conferences?
At a conference I organized in Dallas a few months ago, I asked an all-star panel to consider the question. Panelists included Dallas advisor Richie Lee, arguably the leading out-of-the-box thinker in the NAPFA community; Jim Shambo of Lifetime Planning Concepts in Colorado Springs, Colo., one of the leading thinkers at the AICPA's annual personal financial planning section conferences; and Dennis Stearns, the Greensboro, N.C., advisor who frequently presents on futurist topics. They identified key areas in which advisors may be missing the mark.
Advisors are underestimating client lifestyle expenditures in their retirement plans, Shambo says. He has two problems with the traditional rule of thumb, which suggests that clients' lifestyle spending will increase along with the consumer price index .
To understand the traditional assumptions: Suppose a 40-year-old prospect walks in the door, and you ascertain that she's spending $30,000 a year on the various necessities that make up her lifestyle. You assume her home mortgage will be paid off when she turns 65, and gasoline costs will go down once she's no longer commuting to work. Whatever is left over is projected forward at, say, 3% inflation for 25 years, and that's what you figure she'll be spending each year when she retires. Right?
The first problem, Shambo says, is that the spending growth of younger clients is not driven by inflation, but by income growth. He used himself as an example: When he was 22, he was spending $9,000 a year; when he was 40, he was spending roughly $30,000 a year.
"If I used 3% inflation on either one of those numbers," he asks, "does anybody think that's what I'm spending today, at age 65?"
Not only do you want to give a more accurate picture of future expenditures; you also want to help younger clients control that future income need by showing the consequences of significantly increasing their lifestyle whenever they earn more income.
But when the client reaches retirement, then it's fine to use the CPI to extrapolate future lifestyle expenditures. Right?
Not so fast. Shambo has a litany of issues with the CPI - which assumes, for example, that consumers will substitute hamburger for steak if the price of meat rises, and factors out the cost of better cars, computers and other products (even though your clients have no choice but to spend more if they choose to buy these items).
By Shambo's reckoning, the CPI understates the yearly increase in a typical retiree's cost of living by an average of 33%. Project that difference out over a 30-year retirement, and you're talking about real money.
Shambo's bigger objection to using the CPI as a default is that there is a much better number available: the actual consumption increase data found in the Bureau of Labor Statistics Consumer Expenditure Survey. He showed the audience a graph that indicated an inflation rate of 2.82% a year over a 25-year period. The average yearly rise in consumption over that period was 4.41%.
In his own practice, Shambo creates personalized cost assumptions by asking clients about their spending preferences. At the extreme end, his assumptions might be as high as 55 basis points over the inflation rate.
The current financial planning service model was designed for a very different kind of client, Lee argues. For many traditional planners, a key - albeit hidden - assumption is that clients will have a steady job that will provide a relatively steady income for a relatively stable working life, often with the same employer. So planners simply need to encourage clients to develop good savings habits, manage their assets and project out when they can retire in comfort.
Alas, today's workplace makes this scenario increasingly uncommon. "When I escorted my daughter to college for the first time several years ago," Lee says, "the orientation person said: 'Your daughter is likely to have four careers in her lifetime and nine jobs.' ... For most clients, the sources of income are totally uncertain," he adds.
What does that imply for planning practices? In the past, Lee says, it was possible to build a successful business around tending the golden eggs - that is, client portfolios. In the future, though, the most valuable planning services will be increasingly oriented toward tending the goose that lays them. That may mean a new human capital emphasis: career counseling, helping clients become more valuable in the workplace, helping them create and manage side businesses and, in general, do a better job of monetizing their skills.
Lee also said that advisors will need to do a better job of keeping their clients invested for the long term - reducing the gap between their investment returns and the market returns, which some studies have put at more than 5% a year. And more advisors will need to help reduce various kinds of financial friction, helping clients negotiate mortgages or loans, buy cars and harmonize their insurance coverage.
There are other societal and economic trends that might change some of an advisor's investment and planning assumptions for clients, Stearns argues.
He agrees with Lee's assessment of the job market, saying that according to some predictions, 30% to 40% of careers will be marginalized or disappear in the next 10 years. They will be replaced by another 30% to 40% that don't exist today.
The implication? "What if these wonderful assumptions that we've plugged into client plans regarding salary, bonus and business owner income are way too high?" he asks.
Even widely held forecasts have a bad habit of being wrong, he notes: "Think back five or six years ago when everybody was predicting that we were going to be out of oil, and energy prices were going to go sky high, and what that was going to do to all of our planning assumptions," Stearns says. "Today, that whole landscape has changed."
Current assumptions include that the government budget deficit is out of control, and that Medicare spending on boomer retirees will create a multitrillion-dollar sinkhole of debt. Yet Stearns notes that budget deficits have been declining at a rapid rate this year, faster than at any point since World War II.
And then there's Medicare spending. Diagnostic costs in the last six months of life represent a huge percentage of the total Medicare bill, he notes - so, he asks, "What would happen to our Medicare assumptions if those costs were reduced to practically zero?"
Stearns mentions a $10 million prize to be awarded to any research team that can develop a Star Trek-style "tricorder" - a handheld device that can easily identify a patient's injuries and ailments. The device would have to diagnose a variety of common illnesses and accurately measure such vital signs as blood oxygen level, heart rate, blood pressure, body temperature and respiratory rate. Stearns has clients in the nanotechnology field who are following several laboratories that hope to claim the prize by 2015. "What would that do to our projections if the diagnostic costs dropped 80%?"
Here is Stearns' real point: The 24/7 media has been extremely good at identifying negative trends and problems, and exaggerating them. But it hasn't been nearly as good at identifying positive trends - and Stearns argues that most global events and innovations are moving us in a good direction, rather than the other way around.
The point is to get everybody (the panel audience, you reading this) to think more broadly about fundamentals you may not even realize you're assuming. Don't stop with these suggestions - keep exploring - and please let me know what insights you find.
Bob Veres, a Financial Planning columnist in San Diego, is publisher of Inside Information, an information service for financial advisors. Visit financial-planning.com to post comments on his columns or email them to firstname.lastname@example.org.
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