When everything is going right with your clients’ retirement plans, it’s easy to overlook the potential exposures. But as the bear market and housing slump have reminded us, life is full of surprises.
Dan Richards, owner of consulting firm Strategic Imperatives in Toronto, Canada, says that advisors need to stress-test three parts of clients’ retirement plans:
1) How much they’ll spend in retirement,
2) How much they’ll save for retirement, and
3) The risk they’ll take in investing to achieve their goals.
Stress-testing — also known as scenario analysis — starts with a base case developed on reasonable assumptions for the key variables. Each subsequent scenario modifies a variable — higher inflation, lower portfolio returns, etc. — to determine how the modification affects the client’s retirement plan. Richards details the steps on his blog at www.strategicimperatives.ca:
Stress Test One: Spending
Once you’ve created a base case (perhaps with a high spending and low spending scenario) you can stress test for the impact of higher than expected inflation (a growing concern among some economists due to the record levels of spending by governments around the world) and the effect of unanticipated expenses such as an extended stay in a long term care facility or nursing home.