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What does being prepared for retirement mean to your clients?

30 October 2017 | Topical insights

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Happy retirement cake

Commentary by Colleen Jaconetti, senior retirement strategist in Vanguard Investment Strategy Group.

Here in the northeastern United States, where I work, it's finally beginning to feel like autumn. But I'm already starting to think about the upcoming winter holidays (and a potential family vacation).

Although it's hard to plan for winter when the weather is still mild, I know it's just around the corner … similar to retirement.

Whether planning for a holiday or retirement, it's tempting to focus only on the positives. But you also have to contend with the unknowns, such as bad weather or unexpected expenses. In either case, it's best to be as prepared as possible.

Defining "financial security"

So what does it mean to be financially prepared for retirement? Is it simply having a certain level of assets or stream of income, or is it something a bit more abstract like "having financial security"?

Before you – and your clients – can answer these questions, you need to think about financial goals. Many people have a pretty good handle on what it takes to cover their basic living expenses. But it's important to remember that complexities can arise. How much should be set aside for health care expenses or emergencies? How can a person enjoy retirement but still leave something for family members or charity? Those are big questions with few obvious answers.

To help with the many decisions you and your clients need to make, Vanguard recommends a three-step approach:

  1. Set and prioritise retirement goals.
  2. Evaluate the risks that may jeopardise these goals.
  3. Identify the financial resources that may help achieve these goals and mitigate the potential risks.

Following this framework can you help identify priorities, understand the various trade-offs one may have to make in order to reach goals and, finally, help make the best possible use of financial resources.

Step 1: Set and prioritise goals

While a good holiday destination provides many fun and interesting things to do, you usually don't have time to enjoy everything. That's why it pays to prioritise – differentiating the "must dos" from the "nice to dos”.

Retirement planning is no different. Understanding the hierarchy of retirement goals can help ensure that a person is on track to achieve the highest-priority goals before assigning resources to those lower on the list.

Having a multi-goal framework allows the investor to focus on the relative importance of each goal – paying for housing versus going on holiday, for example – while incorporating preferences such as leaving money to heirs or charity.

Retirement goals tend to fall into four broad categories:

  • Basic living expenses. Food, clothing, recurring health care expenses.
  • Contingency reserves. Home repairs, unanticipated health care expenses.
  • Discretionary spending. Holiday travel, dining out, leisure activities.
  • Legacy. Bequests and charity.

It's important to differentiate the investor's wishes from his or her needs and allocate resources to cover the most vital expenses first. But keep in mind that it may not be possible to achieve all of the "nice to dos"; the investor may have to give up some lower-priority retirement goals.

Step 2: Evaluate the risks

Once the investor's retirement goals have been clearly defined, he or she needs to understand the risks that could jeopardise them. Here are some to consider:

  • Market risk. The risk that market returns will negatively impact the portfolio balance.
  • Health risk. The risk that health will decline and cause a significant financial burden.
  • Longevity risk. The risk that the investor will outlive his or her resources.
  • Event risk. The risk that an unexpected event will have a large financial consequence.
  • Tax and policy risk. The risk that tax and government policy changes will result in additional spending from the portfolio.

It's important to understand a person's sensitivity to each risk. For example, if a portfolio is aggressively invested in equities, it's exposed to more market risk than one that is invested heavily in bonds. However, an overly conservative bond-heavy portfolio might increase the investor's longevity risk.

Once the investor's risk tolerance is determined, consider the implications. How will available resources support the investor if he or she is faced with a worst-case scenario?

Step 3: Identify financial resources

Retirement resources include assets (stock shares, bonds, cash, etc.), income sources (salary, pension, rental income, trust income, etc.), and other financial products (annuities, health insurance, life insurance, etc.).

Retirement resources can be grouped into three categories:

  • Guaranteed income. Income the investor can count on, such as government benefits, workplace pensions, or income annuities.
  • Liquid investments. Financial assets that can fluctuate in price, such as stock and bond funds or other savings.
  • Additional resources. Nontraditional sources of income, such as rental or part-time income, and other products or property that have value, like real estate and insurance coverage.

In many cases, using one resource to mitigate a risk may actually increase a different risk. For example, purchasing an annuity increases guaranteed income but decreases liquid investments, which can help pay for unexpected expenses in the near term.

A sound retirement plan balances the benefits and trade-offs of the investor's lifestyle choices while staying focused on achieving the highest-priority goals. When you apply this framework, you may find the investor is comfortable spending less early in retirement so he or she can afford excellent in-home health care for extended time later in retirement. Or the investor may decide that they want the flexibility to pay for travelling earlier in retirement knowing that he or she will be able to afford basic health care later in retirement.

Start preparing today

When my family goes to the beach, we bring board games, books and movies to keep us entertained if it rains. The same type of preparation can help all of us face what's ahead in retirement: Prioritise goals, evaluate risks and understand the resources at our disposal.

Each person's circumstances, resources and concept of financial security are different, so it's important to customise retirement plan to suit the individual situation. To me, being prepared for retirement means that throughout my life I'll be able to pay for all of my financial goals – including educating my daughters, travelling abroad, owning a second home and leaving a modest legacy. Too ambitious? Maybe. But it's a starting point.

What does being prepared for retirement mean to you and your clients?

Colleen Jaconetti
Senior retirement strategist, Vanguard Investment Strategy Group.

Important information:

This article is directed at professional investors and should not be distributed to, or relied upon by, retail investors.

This article is designed only for use by, and is directed only at, persons resident in the UK. It is for educational purposes only.

This article was produced by The Vanguard Group, Inc. It is not a recommendation or solicitation to buy or sell investments.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

The material contained in this article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.

Opinions expressed in this article are those of the author and may not be representative of Vanguard Asset Management, Ltd.

Issued by Vanguard Asset Management, Limited, which is authorised and regulated in the UK by the Financial Conduct Authority.

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