Retirement Planning: Looking to the Future

In the film “Back to the Future”, Marty McFly transported from 1985 to the year 2015 in the Doc’s DeLorean time machine. The fact that they had flying cars in the future shows how far away 2015 seemed to those in 1985. Now while it is a disappointment that we don’t have flying cars in 2015, it does get me thinking about retirement planning and how people, including myself, tend to underappreciate how close the future actually is.

For example, take the year 2050. For me, 2050 sounds like something from a sci-fi film. Yet that’s the year I’ll reach the state retirement age of 68 (assuming all goes smoothly of course). 35 years into the future may sound far away, but it’s not. This is the real challenge for the pensions industry, effectively communicating to people the need to begin planning for retirement as early as possible in their working career. The numbers would suggest people are thinking about what they need to retire much too late in their career.

Retirement saving is simply a tax-efficient way of accumulating wealth, the wealth need to fund your lifestyle when you finish working. Starting early gives the obvious benefit of a longer time period for wealth to accumulate but more importantly it should cause people to think more about what that wealth goal is. Investment firm GMO published an interesting white paper on this subject last year – “Investing for Retirement: The Defined Contribution Challenge” – and their conclusion, one that I echo, is that members are asking the wrong question. Instead of asking what the maximum expected return for a given level of risk is, the question should be: ‘What is the level of wealth I need and when is it needed?’

It might seem subtle but the difference between focusing on trying to maximise return for a given less of risk and the wealth focused approach is huge. The objective should then not be on trying to maximise expected wealth based on expected returns, but on “minimising the shortfall of wealth from what is needed at retirement”. Take a low risk investor for example. If they have a risk averse personality, under a traditional risk return framework based on modern portfolio theory they will select a low risk fund. However, this might actually increase the risk of shortfall at retirement, in terms of the wealth needed to meet their retirement goals.

Therefore, the real benefit of taking a more comprehensive wealth based approach to retirement planning is that it will cause people to face the cold hard reality. As the guys from GMO point out, if you are a risk averse investor, to meet your wealth objective you might have to:

• Save more
• Work longer
• And/or spend less in retirement

While it may seem like I am sounding the alarm in terms of people waking up to the need to plan for retirement, there is clearly a balance to be struck in terms of planning for the future and actually living in the present. Still, asking the right questions now can leave you better positioned to enjoy the future, flying cars or no flying cars.