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What's your number? How determining your client's retirement comfort zone can be a tricky matter worth trying.

When it comes to retirement, asking someone "What's your number?" is a popular way to land at a rough guess of a typically yet-to-be-determined objective. It's a "kind of/sort of" type of question that results in a "kind of/sort of" type of answer. Usually, the answers fall within the categories of hopeful, fanciful or delusional. Many times, the answers rely upon predictions of future returns. Yet advisors and consumers rarely consider the risks commensurate with the expected returns of any plan. Fortunately there are a few simple ways to tether the answers to reality; the questions "Where am I?", "What are some likely outcomes?" and "What's my number?" can deliver a powerful dose of reality.

Of all the ways to work out someone's "number"--the amount of retirement income required for the client to live at their desired means after they exit the workforce--the most common involve either projecting into the future or pulling the future into the present. The first is the usual way: Project current assets based on some hoped-for rate of return and try to gauge whether the asset value determined for the retirement date is high enough to cover the client's current lifestyle on that date. Alternatively, one could reliably calculate the present value of future lifestyle expenditures and compare this with the current assets, with required incremental savings as the variable to be determined.


At the risk of oversimplifying the problem, the baseline case of tethering to reality is intuitive and requires only a little arithmetic. Imagine that the client is storing their money in a virtual mattress--a Treasury Bill account. Step one is to simply multiply current annual retirement savings contributions by the number of years left until retirement, and then add their current retirement savings. Since T-Bills, on average, earn an interest rate that's close to the rate of inflation, don't bother adjusting for interest--not even at the risk-free rate of growth. The net effect of this cash account is that the assets go nowhere in real, inflation-adjusted terms. This will avoid the illusion of growth by looking at nominal values without accounting for inflation.

Step two follows: Once you have the result of the first calculation, simply divide by the number of years of retirement the client expects. The result is a conservative estimate of where their annual income will end up given today's status.

For example, suppose you're 45 and have retirement savings valued at $400,000. Suppose you're also saving $30,000 per year in various accounts meant for retirement. If you moved all of them to the virtual mattress of a money market account, with 20 years to go until retirement, you can expect the cash account mattress to hold $1 million in today's dollars. If the client thinks that they or their spouse might live for 40 years after retiring, then the implied floor of what the portfolio can provide becomes $25,000, incremented by any Social Security or other external receipts.


Consumers may do better or worse by taking risks in the market, but remember that the questions here are: "Where am I?", "What are some likely outcomes?" and "What's my number?" If the goal of asking "What's my number?" is to learn what accumulation the client will need to achieve in order to weather most markets and most of life's slings and arrows, then there are meaningful ways to provide answers that you can obtain by referencing today's market prices.

There aren't too many people who view their lifestyles as outcomes to be gambled away. Most folks want the comfort of knowing that they'll have something secure--in other words, that they'll possess enough money to avoid having no more than three square meals and a cot to take them through retirement.

The numerical baseline that I like to use is based on the cost of maintaining current lifestyle. I treat that number as a risk-free liability to be put in present-value terms by referencing the cost of buying Treasury Strips--bullet payments stripped out of ordinary Treasury Bonds--designed to pay during each year of retirement. For example, consider two bullet payments: one to be paid on Aug. 15, 2011 and the other on Aug. 15, 2040. The first payment has a market price of $99.92; the payment in 2040 has a market price of $24.56.


If someone wants to know the number for securing $100 on Aug. 15, 2011 and another $100,000 on Aug. 15, 2040, then the answer is simply $100,000 x (0.9992 + 0.2456) = $124,480.

The baseline number shown here begs some follow-up questions:

* How does that compare with available assets?

* Is there anything left for investing for upside?

* If I'm short, can I make up the difference by saving more before retirement, or do I need to rethink my priorities?

One of the beauties of this approach is that it is scalable to lifestyle. It is also easily adaptable for different age cohorts and easy to personalize for non-constant streams.

So far, the result shown is free of credit risk, but we still need to adjust for inflation.


Unlike the market for Treasury Strips, the market for Treasury Inflation Protected Securities is not very liquid. In fact, it's hard to find quotes for any TIP Strips. This makes it a little tougher to match inflation-adjusted cash flows as efficiently as we matched the nominal cash flows above. We can still protect cash flows from expected inflation by adjusting the cash flows for the anticipated effects of inflation. Using the same example as above, assuming an expected inflation rate of three percent means that the cash flow occurring on Aug. 15, 2040 will need to grow by roughly 2.43 = (1.03)30 to keep up with inflation. That means that we'll expect to need $243,000 in 2040 to buy what $100,000 will purchase today. Adjusting the 2040 number for inflation means that our number is now $100,000 x (0.9942 + $243,000*0.2456) = $159,601.

Mike Zwecher is a managing director in the control structure of Deutsche Bank, and an expert in retirement income and risk management. He can be reached at 2/2-250-3070 or
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Author:Zwecher, Mike
Publication:Agent's Sales Journal
Date:May 1, 2011
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