Part 1: Are Traditional Financial Models Limiting Your Retirement?

1. We estimate how much money you’ll have at retirement.
2. We estimate how much you’ll spend each year until your death.
3. We estimate how investing the money helps it last longer. 

There are other complexities to account for, of course. We incorporate taxes on your income and portfolio withdrawals. We track other sources of income such as social security or pension income. We account for any large purchases or windfalls that you expect, and we incorporate goals other than retirement that are important to you. Other factors include inflation, insurance, estate planning, etc. But the core of that plan is the 3 steps outlined above. 

Most of those assumptions are held fairly constant in the planning process, except for investment returns. If we assumed a constant market return throughout the plan, planning would be easy. In reality, returns are volatile, so we account for that in a process called Monte Carlo Simulation. 

Monte Carlo Simulation for Retirement Planning

Imagine you’re rolling a pair of dice. We know 7 is the most likely roll as you can get there with a 1 and 6, 2 and 5, and 3 and 4 (16.7% chance). Conversely, the only way of rolling a 2 is to get 1 and 1 (2.8% chance). For any single roll, the outcome is mostly random. If you roll 5 times, you might get 5, 12, 4, 9, 3. However, if we roll 1000s of times, I can tell you within a small margin of error how many of each number will come up.

It’s similar with market returns. We have enough market history to get a good sense of how different investments behave over time. So, we enter some statistical parameters that model market returns and simulate different returns for every year in the plan.

If we simulate every year in a plan, we basically end up with one possible retirement scenario. An example below for someone with $2 million at retirement with 30 years till death.

Those returns appear somewhat random, but will revolve around an average return we choose, and deviate from that average by amounts that roughly match history. We then use the computer to create a distribution of possible outcomes. If we simulate a 30-year plan for 10,000 scenarios, that’s 300,000 return estimates. 

By creating many different return scenarios, you can see there are times when returns are good, and you end up with much more wealth than anticipated, and the opposite, when your wealth reaches zero before the plan is over (red lines). 

You count how many of those scenarios still have money at the end, and divide it by however many trials you ran, and you get probability of success. So, if 800 of the 1000 scenarios are positive, that’s an 80% probability of success. You’ll recognize this if you’ve had a plan done in Money Guide Pro.

Many Financial Planning Assumptions are too Conservative

There’s a famous quote that says “all models are wrong, but some are useful.” I think that perfectly encapsulates financial planning software. Financial plans give you a lot of great information. They account for all your assets and liabilities, make reasonable assumptions for spending and investment returns, but we all know it won’t perfectly match reality. That’s still useful!

The problem is these plans aren’t just for your amusement. We’re making real decisions about how much you can spend, leave to heirs, and how you invest based on these assumptions. So, we want the model to be as realistic as possible so we act on the best information. Many of the assumptions used in traditional financial planning are conservative, and some are overly cautious. Here are some examples.

• We assume spending grows at a constant rate every year until death, however data from JP Morgan Chase suggests households in the $1-$3 million investable wealth cohort reduce their spending throughout retirement.
  
  
• We assume spending doesn’t adjust to markets and the economy. In reality, people often reduce spending in a recession (by definition really), and that is not reflected in plans. 
• Portfolios are static throughout the life of the plan regardless of how circumstances change. A static asset allocation also assumes client’s pull money out of stocks each year, regardless of recent performance. What if you just sold bonds in bad years, and let stocks recover?
• Traditional planning software assumes you withdraw from the portfolio at the beginning of the year, meaning any market returns for the year are applied to the reduced portfolio. This lowers your compounded return.
• We exclude a variety of assets from being used in retirement, including client’s home(s), personal assets like jewelry or collectibles, the cash value of life insurance, and often outside cash. 
• We run most financial plans out to around age 93 (give or take) for both spouses. The likelihood that both spouses live to 90 is about 6%. 

Due to the conservative assumptions shown above, the true probability of success is likely higher than what you see in your retirement plan. We want to maximize our clients spending and wealth at the end of their life, and we can’t do so if financial plans are assuming the worst. 

Other issues with the current financial planning approach:

• Misinterpretation of probability of success. This measure is framed solely as success or failure, a successful retirement or financial ruin. That is ridiculous. We don’t go to sleep for 20 years only to wake up to a plan that’s been failing. We adjust as we go. 
• Because clients view probability of success as “pass or fail”, they tend to gravitate towards the traditional numbers representing pass and fail. Anything under 70% is considered failing, and client’s strive to have their plans achieve an “A”, or 90%+. In our view, a plan at 90% means you aren’t spending what you could, or you aren’t planning for what those assets will be used for after you’re gone. (this will be covered in detail in a future post) 
• Clients struggle to conceptualize how the assets they’ve accumulated can be spent or passed on in an optimal way, which makes setting goals difficult. (see next section)

What’s the Why?

I have a daughter who just turned 3, and she’s at the age where she’s soaking in everything like a sponge and learning how the world works. Watching a movie with her is one of the funniest things to me. It starts with her asking a simple question, like “Why does Ariel have legs now?”, because in The Little Mermaid she turns into a human. And that quickly turns into a chain of “Why?” questions until I simply can’t come up with an answer that makes any sense, and I have to say, “I don’t really know, to be honest.”

The great thing about asking a bunch of “why’s” is that you quickly get to the root of any topic. Clients should do the same thing when it comes to retirement planning. 

Question:  "Why did you hire WJ Interests to create a financial plan for you and your family?"
Answer:  "Because I want to retire."

Question:  "Why is retiring important to you?"
Answer:  "Well, I’ve worked hard, and I want to enjoy life without worrying about work."

Question:  "What does “enjoying life” mean to you?"
Answer:  "I want to spend my time doing the things I love, like traveling and being with family."

Question:  "Why are traveling and being with family important to you in retirement?"
Answer:  "Because I feel like those are the things that will make me happiest and give me purpose after I stop working. I also want to help people."

Question:  "Why is helping others important to you?"
Answer:  "Because I want to leave a legacy for my family and make a positive impact on people’s lives."

Question:  "And why is leaving a legacy important to you?"
Answer:  "Because I want to be remembered for more than just my career—I want to make sure I used my resources to take care of my family and contribute to something bigger than myself."

Now we know the why. It’s to travel and spend time with family while using your resources to take care of the people you love and contribute to something bigger than yourself. The goal is not “to survive without running out of money.”

Solving for a static number like probability of success, that never accounts for your dynamic behavior throughout retirement, using overly cautious assumptions, will not help you live out your why? In fact, it often does the opposite. 

Due to a fear that’s sometimes caused by the financial planning software itself, clients hold back. They don’t take that big trip, they don’t move closer to family, and they don’t pursue their passions, because they look at a plan with 90% probability of success and see a 10% chance of ruin. 

Clients also rarely plan for assets they’re likely to leave behind. If you don’t define a legacy goal, you’re saying you want to die with zero. Which is fine, except we know from client behavior that they rarely spend money like they want to leave zero. Most probably assume they’ll leave a legacy, but what does it matter if you leave $8 million versus $5 million. “We’ll be gone” is a common response. 

We want to help clients better conceptualize the value of their wealth, whether it’s to their family or causes they’re passionate about. Whether it's giving that money away now, or at death. We’ll focus more on this in Part 6. 

In the following parts of this series, we’ll discuss how a dynamic approach to both spending and investment management, as well as reframing how we measure retirement risk, can help clients achieve their why. 

This means giving clients the confidence that they can spend more, in many cases significantly so. It means more precisely estimating what is likely to be left behind, and optimizing those assets to have the most impact when they are passed on. And all this while being able to lay your head at night, knowing you have enough to do so. 

At WJ Interests, we help you move beyond traditional retirement planning to maximize your wealth and live out your goals. As a trusted resource in Sugar Land, TX, we’re here to guide you toward a confident, meaningful future and lasting legacy.

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