Most investment advisers offer some form of investment planning for retirement. Sometimes it can start and stop with a few rules of thumb; fund an “emergency fund”, max out your 401k, identify an age- and situation-appropriate risk profile, live within your means and check back when you are 65 to see how you did. Alternatively, you can do some fancy income, expense, goals and investment modeling with some of the great investment modeling software available to advisers to come up with a probability of success. Depending upon your age and financial situation, it can be very useful or overkill. Let’s take a look at the differences.
If you are under 40 or 50 years old, you have a long time to go before you retire; probably 25 or more years – when a lot can happen. Though you can certainly model out all of your “known” financial and non-financial considerations to get some insight into your financial future, I can guarantee you that you will be wrong and miss some important unknowns that will throw a kink into your plans. Usually, it makes best sense simply to do some high level planning and stick to a simple approach.
On the other hand, if you are 50 or older you will likely have a much better handle on how the next 10 or so years will evolve and can take meaningful steps to help ensure a high probability of success to fund your retirement goals and expenses. It makes very good sense to map out a budget of income and expenses with short-, medium- and long-term goals and overlap that with your investment portfolio and projected savings to see how it could perform until your “end of plan” (when you die!). Your goals will include things like European vacations, a Florida condo, a new car every five years and whatever else you can think of. Your expenses and goals need to have an inflation adjustment, too, with things like health care expenses getting a higher inflation adjustment.
Unlike a more generic approach, a modeled approach with realistic cash flow assumptions allows for a statistical measure of the “probability of success”, i.e. the chance that you will reach your end of plan with the means to fund it over your retirement period! After considering your income from all sources, e.g., part-time work, pensions, annuities, social security, required minimum distributions from tax-deferred accounts, etc., and your expenses and goals, it is useful to overlay scenario testing of different risk-based investment portfolios over your planning horizon.
For example, you could find that an aggressive portfolio could have a higher probability of success (maybe 80%), but the large drawdown in any one year (perhaps -30% or more) is too big a risk to take in any one year. In that case, you may opt for a lower risk portfolio (with maybe a 70% probability of success), but with only a -15% drawdown. Modelling software helps to fine-tune the risk profile of a target investment portfolio to your retirement needs and desires.