Retirement Planning - why assumptions are important

For most of our clients, have the freedom to retire one day is a core financial planning goal.  For a lot of people, this means having the choice about whether they work, or how much they work, or what kind of work they do.

Whilst ‘retirement’ is changing these days, with a number of our clients transitioning into retirement and spending a period of time ‘consulting’ or working part time, the reality is that at some time in your life, it is likely that you will end up living on your accumulated savings/investments/assets.

There are a number of ‘rules of thumb’ that have been bandied around over the years about how much you need invested to ensure that you can financially make it through your retirement.  These include something like 75% of your income before you finish work, $1 million. $500,000.

The reality is that every person/couple is different.  Over the last 18 years of putting together financial plans and working with our clients, we have yet to meet anyone who spends the same amount or in the same way as another person.  Everyone has different priorities.  You may want to provide funds for your children as a ‘pre-inheritance’, you may have elderly parents that you want to look after, you might have an expensive pastime that you have to cater for.

Your retirement planning is an important part of your financial planning and in our opinion, it is worth putting the time and effort into getting a good structure around your planning.

What are your assumptions?

The most important aspect of your retirement planning is the assumptions that you have put into that planning.

Changing any of the assumptions will change the amount of funds that you require to see you through retirement.  Changing assumptions can also have a big impact on how much you need to put away now for your retirement years.

At Moneyworks we have built several retirement calculators that we personalise for our Membership Fee clients (clients that we meet with every year).  These calculators can incorporate a number of variables that produce graphs to show the impact of those assumptions.

Key assumptions that you need to take into account include:

1. How long are you going to live? If you are part of a couple will you both live the same length of time?

As we get healthier and as medicine solves more issues, we are living a lot longer.  If you make it to age 65 these days, you are highly likely to live until age 85.  A child born today in the developed world will live on average to age 95.  The last thing you want is to outlive your money.

2. What do you spend now, what will change when you ‘retire’?

How much will you spend in todays dollars (we need to adjust for inflation), after tax?  Will that change during your retirement – will it reduce as you get older?  Do you need to allow extra for travel?  Do you need to allow extra for whiteware and vehicle replacement?  For house maintenance?

3. When will you retire?

Will you just stop work at a particular age?  If there are two of you, will you both stop income earning work at the same time?  Or will you carry on working for a while as a consultant? or part-time?  Or will you take a lower stress, lower paying job to keep up your social contact?  One of the things about retirement that we regularly read is that retirement can be socially isolating.  Do you want to consider volunteer or paid work to keep you stimulated?

4. How much will you get from NZ Superannuation?

When we started working with our Membership Fee clients in the late 1990’s it looked like NZ Superannuation would be reduced and phased out.  At present, it looks like NZ Super at its current levels may be around for some years yet.  In future the age of eligibility may increase, or the linking with inflation may change, or (an extreme possibility in our opinion) the entitlement may become means (asset) or income tested.  You need to work out how much you think you are going to get from NZ Super in your retirement.  At present, if there are two people in the same house who are entitled, and your marginal tax rate is 17.5% each, you will receive just under $30,000 pa after tax.  If you are single and living alone, with the 17.5% tax rate, you will receive just under $20,000 pa.

5. What are you going to earn in retirement from working?  For how long?

6. Will you receive an income from GSF, NPF, Overseas or other pensions?  Is that taxable?

7. Will you repay your mortgage before you retire?  Or are you planning on releasing funds from downsizing your home?

8. What investment returns will you get?

The choice of investment return that you make can make a big difference in how much you need to save to achieve your goals.  At Moneyworks, we always use after tax, inflation and fees returns.  We use international research to work out what return to use and depending on the risk profile of our clients, the returns will vary between 1% and 3%.  The calculators that we have developed compare the impact of different rates of return, so that it is easy to visually assess the impact.

9. Are you anticipating getting an inheritance that will help you with your savings/funding of your retirement?

If you would like more information on planning for your retirement and the value of working with Moneyworks and Carey, Peter and Paul as an adviser as a Membership Fee Client, email us atcarey@moneyworks.co.nz and we will get in touch with you to arrange a discussion with you.

Investment returns - why assumptions are important

I am sure that you have heard the saying 'there are lies, damn lies and statistics'.  As Wikipedia eloquently says:

Lies, damned lies, and statistics" is a phrase describing the persuasive power of numbers, particularly the use of statistics to bolster weak arguments.

One of the things that annoys me most about investment advertising is when the graphics or comparisons don't state what the assumptions are behind the stated investment returns.  Unfortunately, this practice also extends to journalists articles and associated graphics and sometimes to investment statements and brochures.

Like apples and oranges, you need to ensure that you are comparing the same thing before you draw any conclusions.  There are many ways that investment return statistics can be used to 'persuade' by comparing apples and oranges.

What are the key assumptions that you need to know about when you are comparing investment return claims?

1.  What is the role of Tax, Inflation, Fees?

Fees: Are the returns before or after fees?  If the assumptions say that they are after fees - which fees?  The investment managers fees?  It is normal practice to quote investment returns in Australia and New Zealand after investment manager fees.  But does this include any performance fees?  What about financial adviser fees?  Are they paid out of the investment manager fees (this is the norm in KiwiSaver) or are they charged in addition (this is the norm in an advised portfolio on an investment WRAP platform).  How much are the adviser fees?

Taxes: Historically in New Zealand, investment returns were quoted AFTER TAX.  However, on 1st October 2007, when the PIE/PIR tax regime began, investment returns for PIEs are now traditionally quoted before tax.  Are you comparing an after tax number with a pre-tax number?  What tax rate was used?  Is that the same tax rate that applies to you?  This change makes it extremely difficult to compare investment returns pre 1 October 2007 and after that date.

Inflation: Inflation is the silent thief that takes away your purchasing power.  At Moneyworks, when we are doing our planning for clients retirement, and when we are teaching our clients how to plan for the future, we always use after fees, tax and inflation numbers.  We have to make an assumption about inflation, but this means that we are comparing future dollars with today spending (putting the expenditure and assets into today dollars.) Advertised Investment returns rarely incorporate this adjustment.

2. What dates are you comparing?

It is vital that the dates that you are comparing are EXACTLY the same.  I have had several situations over the last 20 years where I am been asked to comment on investment returns to say the 28th February, when all the other information available is only available to the 31st March, or 31st December.  This is particularly so with 'private' type offerings and offerings from organisations such as Medical Assurance (who I believe are gradually changing to a unitised basis, so that their returns can be quoted more than twice a year.)

Even one day makes a difference.  To give an example. The following are returns for the last 12 months for a clients balanced portfolio where they are not making any regular investments.

As you can see, even with one days difference, there is a difference in return.  It is vital that you compare exactly the same dates and exactly the same time period.

3. Have regular contributions been made to the investment or was there just a lump sum at the start of the year?

When you are making regular contributions (like most people do to KiwiSaver), this will affect your return.  This is because if you only had say $10,000 invested at the start of the year, then it is easy to work out the investment return, as it will be the increase in value at the end of the year.

But if you start off with $10,000 and add $1,000 each month, then from month 2 there was $11,000 invested, from month 3 there was $12,000 invested and so on.  You need to use the appropriate formula to correctly calculate the investment return on each different balance between that date and the end of the year that you are looking at.

At Moneyworks, we purchase specific software that enables us to produce these reports for our clients KiwiSaver investments.

It is important to make sure that you don't compare investment returns where there are no regular contributions with your actual investment returns if you are making regular investments.

4. What is your risk profile?

There are five main risk profiles that are used in the investment world.  Increasing in risk they are: Defensive, Conservative, Balanced, Growth and Aggressive.

Each of these risk profiles will have a long term benchmark for each main asset: Cash, Fixed Interest, Property, Australasian equities (shares) and International Equities.  As each of these assets gives different returns in different markets, you need to ensure that you are comparing the same risk profile.

Even then, within 'balanced' funds as an example, with the main KiwiSaver Balanced Funds that we monitor, the current allocation to 'growth assets' (Property and Equities) ranges from around 54% up to 69.3%.  So even though they are all 'Balanced' Funds by label, they can't be accurately compared to each other as the fund with 69.3% growth assets will have significantly more risk than the fund with around 54% of growth assets.

It is important that you know what the asset allocation of the investment portfolios are that you are comparing.  And, if the asset allocation of one portfolio has changed more than once during the year, and you are comparing it with say a 50/50 portfolio, you will get nonsensical information.

5. Artificially constructed numbers

Possibly my biggest gripe is reserved for organisations that present information that I will politely call 'artificially constructed'.  These numbers are presented for clients to compare against their existing returns.  However, unless people know how to compare information, it is very easy to not notice, or not understand the importance of the assumptions.

Here is an example of the wording of the assumptions in the small print of one firms website (with identifying information removed):

"Disclosures: All returns are net of management fees, but before adviser monitoring and custodial fees.

All returns are gross of tax.

[OUR] asset allocations have changed over time. All returns are based on our current asset allocation model.

To read more - click here.

An amusing topic of conversation for all socio-economic groups, ages and sexes. BUT - here is proof - no, women are not bad drivers. Now, there could be a number of reasons for that... Maybe women don't drive as far? As much? Hmmmm. Some light relief for a cold July.

An amusing topic of conversation for all socio-economic groups, ages and sexes. BUT - here is proof - no, women are not bad drivers. Now, there could be a number of reasons for that... Maybe women don't drive as far? As much? Hmmmm. Some light relief for a cold August.