I've written many times on the topic of "retirement planning". Whether you think it's a valid concept or not is not something I want to address in this week's blog post. I do want to talk about the idea of the "moving target"-another huge elephant in the room-of the financial planning industry.

The "moving target", or "targets", are interest earnings and inflation.

When a financial planner sits with a client, and the client asks "so, how much money do I need to save every month?", there are several other questions and assumptions that will be automatically figured into the adviser's answer.

For the most part, financial advisers nowadays use computer software to try to calculate retirement savings needs for clients. These programs are affectionately called "monte carlo simulators". As the name suggests, these programs are very "casino-like" in their calculations.

The software is comprised of a series of formulas. Numbers, or assumptions, are input into the software program, and the simulator runs calculations to give the adviser and the client several "best guesses" as to what the client needs to do to reach their income goals. The output is totally (or almost totally) random in the best of simulators.

I want to stress "guesses" when it comes to these software programs. Math tells you "if ______ then _______". The "if" is the variable. If the "if", or the assumption, of your mathematical formula changes or does not reflect reality, then the rest of the calculation is meaningless.

Financial planning today relies largely on assuming that inflation and an "average" investment interest rate is known for the next 30 to 40 years of a client's life. But this is no easy task. First of all, is your adviser using overall or general inflation, or core inflation? Do they factor in price inflation or monetary inflation? Do they understand the difference between the two?

And, if they understand the difference between the two, do they know what the Federal Reserve, or any other central bank, will do for the next 30 to 40 years in terms of raising or lowering interest rates? Chances are, they do not, and that's only one assumption they are trying to guess.

But most advisers, if pressed, will admit that they are offering only hypothetical assumptions about how well your investments will do and what inflation will be. This also means that they are only offering hypothetical assumptions about how much you need to save. Are you beginning to see the problem inherent in saving money for retirement?

There is no way I can cover all of the possible alternatives to deal with this uncertainty here in this post, but the first step is to create a comprehensive personal budget plan. A good personal budget will help you concretize your financial goals, tie them into your personal values, organize your assets and liabilities, and give you certainty about that which you can control-your income and expenses. 

From there, it might be helpful to work with a financial adviser that can show you an alternative to guessing at what inflation and your investment returns will be for the next 30 to 40 years.

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This entry was posted on June 27th, 2010 by David C Lewis, RFC. Edits may have been made to keep this entry current. · 2 Comments · Asset Preservation, Insurance & Savings, Investing, Retirement Planning