Better Financial Management in Retirement Through Better Metrics

In
several of our recent posts, we have been touting the Actuarial
Approach and its use of the Funded Status metric to measure household
financial health. This is another one of those posts.One of my
Bridge buddies recently mentioned the Peter Drucker quote, “You can’t
manage what you can’t measure” which highlights the importance of
incorporating quantifiable metrics in managing and improving business
processes. Mr. Drucker’s quote is equally applicable to the process used
by households (and financial advisors) to manage their finances in
retirement.The Actuarial Approach actually employs two Funded
Status metrics—the first which compares the present value of household
non-risky assets and investments with the present value of its essential
expenses and the second which compares the present value of total
household assets with the present value of total household spending
liabilities. The first metric can be used to manage investment of
household assets and investment-related risks, while the second can be
used to broadly manage household assets, spending and risks from actual
future experience differing from assumed future experience.The
beauty of the Funded Status metrics is that if all assumptions are
realized from one year to the next (including the assumption that
spending will equal the spending budget for that year), the Funded
Status is expected to remain unchanged. If the Funded Status increases
(or decreases) from year to year, experience losses (or gains) have
occurred. Using this self-adjusting process and monitoring these losses
or gains over time will be valuable in determining when adjustments in
the household plan may be required.Risks that actual future
experience may differ from assumed future experience are easily
quantifiable by changing default assumptions in the Actuarial Financial
Planner (AFP) and noting the impact on the calculated Funded Status
(i.e., stress-testing). Quantifying these risks will help households
develop strategies to manage them.Measuring and monitoring your Funded Status can also help you manage many financial decisions in or near retirement, including:Timing of retirement,Whether you should decrease or possibly increase your spending,Timing of Social Security benefit commencement,Whether to take benefits from a defined benefit pension plan in the form of a lump sum or a life annuity,Whether to purchase a life annuity product or Tips ladder, andWhether
to go back to work or take a part-time job in retirement or look for
other sources of income (such as renting a room or other space in your
home).SummaryIf you want to
properly manage your finances in retirement, you need to incorporate a
reliable metric or two into your planning process. We believe the Funded
Status measures that you can calculate using our Actuarial Financial
Planners are just the ticket.