Seven retirement questions all advisers should ask

The answers can prove pivotal in setting up an investment program for clients, says professor

Apr 30, 2012 @ 1:45 pm

By Darla Mercado

The true philosophy of retirement planning can be boiled down to seven key questions advisers should ask their clients.

That was the thrust of the keynote speech Moshe Milevsky, associate professor of finance at York University, made Monday at InvestmentNews' Retirement Income Summit in Chicago.

Mr. Milevsky encouraged advisers to back away from black-box models that merely spit out a number to be used in planning for retirement.

Rather, it's all about the assumptions that advisers use to reach that income level in the first place: What are the questions advisers should be asking their clients, and what's the math behind pulling those assumptions into income retirees can use?

“Retirement income planning is more than just a math problem, but you can't avoid the numbers entirely, either,” he said. “We want a slightly deeper appreciation for who's behind it and where it comes from.”

1. “How long will your money last if you stop working today, invest your nest egg as safely as possible and try to maintain your current standard of living?”

A basic building block of retirement planning, mathematician Leonardo Fibonacci's equation to determine the present and discounted value of money gives the number of years a lump sum will last if an investor spends a given amount per year, assuming a certain rate of return for the principal.

2. “How long will you spend living in retirement, and how random is that number?” Benjamin Gompertz, one of the first actuaries, developed the mortality law: He determined that the death rate for a given age cohort rises each year of your life by about 9%. Accounting for factors such as wealth and health, plus higher odds of longer lives as a person ages, investors are generally expected to spend a long time in retirement.

3. “What is your pension annuity worth? How much does it cost to buy more lifetime income?” Astronomer Edmond Halley essentially discovered that the value of a pension depends on age and discount rates: A pension annuity is worth more at a younger age and less when older.

4. “What is the proper spending rate from our nest egg, and what economic factors does it depend on?” Economist Irving Fisher wrote about longevity risk aversion. Investors typically prefer to enjoy more of their money earlier in retirement, realizing that the odds that they'll make it to 100 are much lower than the chance they'll make it to 70.

5. “What's the proper mix of stocks versus bonds?” Paul Samuelson, an economist, brought the concept of human capital into the financial planning equation. Human capital tends to fall as people age, and at the same time, financial capital rises. Generally, the more secure an investor's human capital is, the more investment risk they might take.

6. “How important is leaving financial legacy? What is it really worth?” Solomon Huebner, an insurance economist, demonstrated the value of life insurance. The value of a death benefit may not be much at a younger age, but it rises as an insured individual ages and life expectancy shortens. It's worth even more when interest rates are high.

7. “Taking everything into account, is your retirement income plan sustainable?” Mathematician Andrey Kolmogorov came up with the lifetime probability of ruin, which posits: “Will I run out of money before I run out of life?”

Pulling together all of the above equations, advisers can try to determine not just a portfolio's sustainability but make decisions on annuitization.

“There are some basic equations that all financial advisers should be aware of,” Mr. Milevsky said. “Retirement income has its own important equations. Turning something into a field — a profession — is about: Where did it start, and who are the heroes?”


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