Financial planning is only as robust as the assumptions underpinning it. Every retirement plan relies on expectations regarding inflation, investment returns, life expectancy, Social Security benefits, and periodic expenses. Unfortunately, many financial plans falter because these assumptions are not meticulously scrutinized or tailored to individual circumstances.
At Strategic Income Group (SIG), we adopt a conservative yet flexible approach to financial assumptions. While we utilize prudent estimates based on historical data, we collaborate closely with each client to customize these assumptions, ensuring that every plan is both realistic and personalized.
In this article, we will explore:
- The significance of financial assumptions in long-term planning
- The substantial impact of minor changes in inflation or growth rates on retirement income
- How SIG’s investment process enhances the probability of financial success
Key Financial Assumptions That Shape Your Future
Inflation Assumptions: Guarding Against the Erosion of Purchasing Power
Inflation poses a significant risk to retirees, as underestimating it can lead to a substantial loss of purchasing power over time.
- SIG’s General Assumption: We typically assume a 3.25% inflation rate for most expenses, grounded in historical data.
- Customized Approach: For clients with considerable healthcare costs or other expenses that escalate at a higher rate, we adjust the inflation assumption accordingly to create a more accurate and tailored plan.
Example of Inflation’s Impact:
- If you require $5,000 per month today, at a 2% inflation rate, which many financial advisors use and is the current FED target rate, you would need $7,459 per month in 30 years.
- If inflation is actually 3.25%, you would need $8,866 per month—resulting in a 19% shortfall if underestimated.
Growth Rate Assumptions: Balancing Optimism and Realism
Many planners assume aggressive investment growth rates, often between 7% and 10% annually. At SIG, we adopt a more conservative stance:
- Real Estate Growth: We assume a 3.00% growth rate.
- Stock Market Growth: Our assumptions are based on conservative historical estimates.
Impact of Overestimating Growth Rates:
A 1% overestimation of investment returns over 30 years can lead to a 20-30% shortfall in assets. For instance, a retiree expecting $1 million might end up with only $700,000 to $800,000, significantly impacting their financial security.
Learn more about our investment philosophy on our Investment Management page.
Life Expectancy: Planning for Longevity
While many financial advisors assume a life expectancy up to age 85, statistics indicate that one in ten retirees will live beyond 95.
SIG’s Approach: We generally plan for a life expectancy of 95 years to help ensure that clients do not outlive their resources. However, we adjust this assumption based on each client’s health, family history, and personal preferences.
Social Security Assumptions: Preparing for Future Uncertainties
Given concerns about Social Security’s long-term funding, SIG assumes only 67% of projected benefits for clients under age 50.
Rationale: The Social Security Board of Trustees projects that by 2035, payroll taxes will only cover 75% of scheduled benefits. By adopting a conservative approach, we help ensure clients are prepared for potential reductions in benefits.
Unexpected Periodic Expenses: Addressing Hidden Retirement Risks
One often overlooked aspect of financial planning is accounting for unexpected, yet inevitable, periodic expenses. These large, non-recurring costs occur every 3-4 years and can significantly impact a retirement plan if not anticipated.
SIG’s Approach:
- “Unexpected Periodic Expense”: We include this category in each plan, tying it to the client’s net worth or home value.
- Example:
- A client with an $800,000 home might have an additional expense of $8,000 every 3-4 years, adjusted for inflation.
- We also factor in other non-recurring expenses, such as vehicle purchases, major home repairs/remodels, and medical expenses.
Impact:
Failing to account for these expenses can lead to a faster depletion of retirement funds, resulting in potential shortfalls in later years.
SIG’s Investment Process: The Bucket Strategy
At Strategic Income Group, we employ a structured bucket strategy to manage market volatility and ensure reliable retirement income.
Reserve Bucket (0-12 Months)
- Composition: Cash and money market funds
- Purpose: Covers immediate needs without market exposure
Income Bucket (Years 2-4)
- Objective: Achieve a return above the Federal Reserve’s target inflation rate (2%)
- Strategy: Reduce the loss of purchasing power with minimal volatility over a 2-4 year period
Income+ Bucket (Years 4-7)
- Objective: Earn a return and risk profile in line with the Morningstar Conservative Index over a full market cycle
- Composition: Includes public and private fixed income as well as alternative investments
Wealth & Wealth+ Buckets (7+ Years)
- Composition: Equities & alternative investments
- Purpose: Designed for long-term growth to outpace inflation
Why SIG’s Approach Increases Your Financial Success
- Conservative yet flexible assumptions tailored to each client’s needs
- A structured bucket strategy for managing market volatility
- Lower risk of running out of money due to overoptimistic projections
- Higher probability of financial success (90%+ Monte Carlo probability)
At Strategic Income Group, we believe that financial planning should be built on wisdom, diligence, and biblical stewardship. Our approach ensures that clients can retire confidently, knowing their plan is built on truth and tailored for long-term success.
Take the Next Step
Want to see how these assumptions impact your financial future? Schedule a consultation with Strategic Income Group today.
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Disclosures:
Strategic Income Group (SIG) provides financial planning and investment management services tailored to individual client needs. The assumptions used in financial plans are based on historical data and current market conditions but are subject to change. While we take a conservative approach, all assumptions are reviewed with each client and customized as necessary.
Investment allocations provided are examples of target allocations and may vary based on client-specific factors such as risk tolerance, time horizon, and financial goals. Past performance is not indicative of future results, and all investments carry risks, including the potential loss of principal. Clients should consult their financial advisor for personalized advice before making any investment decisions.
