So the title (Retirement 101: Planning for FV=PV(1+i)t3) of my article is a bit odd, you say? Maybe it is to you, but it most certainly shouldn’t be to a professional financial advisor. I find it curious how so many advisors all across the country fail to solve for FV. What is FV, you ask? It represents “Future Value” (as in, the future value of your money) of course.
Why is factoring inflation so important to the hard-earned asset base that you have accumulated to support your income needs in retirement? Because having a financial plan without effective calculation for inflation is a definite way to ensure your retirement fails miserably!
As an advisor for nearly 20 years, I have had the good (and bad) fortune of being a party to many different economic trends and massive amounts of volatility. I have seen the exuberance of the 90s, the chaotic crash between 2000 and 2002, the following rise to all-time highs in 2007, and the mighty collapse that followed.
I would have never believed that the federal government would basically correct the latest crash through the false stimulus known to most of us as quantitative easing. For those of you who are unfamiliar with this method, quantitative easing was the federal government’s way to use the Federal Reserve (the Fed) to manipulate interest rates and print enough money to buy all the treasury bonds it needed to keep the U.S. afloat. Our government has utilized quantitative easing at record levels in an effort to help the U.S. GDP (Gross Domestic Product) expand. The stimulus provided by the Fed has made U.S. investors confident enough to step back into the markets, and as a result, we’ve seen a meteoric rise from the ashes of 2009 to record highs again. With trillions in debt, can the Fed continue this trend? Our lawmakers in Washington would just as soon continue the trend and “kick the can” of responsibility down the road. We as Americans will ultimately have to pay the price for the indiscretions and irrational spending behavior our federal legislators continue to demonstrate.
Through it all, inflation has never wavered. I’ll grant you that over the last 100 years it has not necessarily been possible to predict exactly what inflation will do year-to-year; it is far more random than that. However, over the last 25 years of this gloriously suspect economy, that is now more than ever a global economy, the inflation rate in the U.S. has averaged roughly 4.2%. I’ll admit the last 10 years have produced at a rate far less than that, but it speaks to the fact that inflation is also a volatile measurement that cannot be ignored when planning for retirement.
Perhaps a mere 4.2-cent reduction in the value of every dollar you have each year doesn’t sound like a big deal. Kindly indulge me: Let’s take a look at a smaller number, 2.5%, as a baseline. If we had just 2.5% inflation going forward and only used simple interest here (no compounding), each dollar you had would be worth 25% less every 10 years. WOW! Some experts think that the current market conditions will continue to produce low rates of inflation; other economic gurus suggest “hyperinflation” is a very real possibility in the near future. Given the economic expansion since the 2008 market collapse, as interest rates inevitably begin to rise to more normal valuations, inflation will most certainly follow.
Inflation is measured by the federal government’s Consumer Price Index (CPI). This index takes into account many potential factors in the underlying economy to produce its values. The funny thing is: This index does not include food or energy costs in the calculation. So is it really a wonderful overall representation of how your dollars will be affected every year you are alive? I say probably not. It doesn’t even include two of the main staples that we all, regardless of who we are, have to use every single day.
So what is the point of this article? Too many advisors are effective at gathering your assets and selling you “their solution” to your planning needs, but very few of them ever carry out real asset planning that effectively prepares retirees for the reality of how much more cash flow they will need to maintain the income they desired at the onset of retirement.
When I began my career, the way we were taught to create income in a portfolio was to “ladder” out bonds, CDs and other income-producing instruments that would provide the income target for each individual client. Then, in the mid-1990s, it was much easier to do. While a raging bull market supported the economy, there were many solutions to meet income needs, and solving the equation was frankly not very hard. As a matter of fact, the interest on the money market accounts back then paid north of 6%. If I could get that today and lock it in, everyone would want to be a client of mine!
Today, we face serious challenges to find solid solutions due to exceptionally low interest rates and much more market volatility. As advisors, we have had to become creative with clients, both new and old, to garnish income that is stable and relatively safe. On many occasions, using insurance annuity tools with guarantees to meet income needs is far-and-away the safest and most effective solution. Now, factor for the preexisting need to solve for the inflationary pressure that can erode the spending power of our FUTURE VALUE, and the planning process takes on an even more powerful role.
My advice: Drill your current advisor on this subject. Be certain that they can show you how your portfolio is designed to insulate you from inadequate cash flow in the future. If the advisor appears puzzled or unable to do this for you in a manner that is clear and easy to understand, maybe it is time to get yourself a new advisor!
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