Collins/Gadenne Article
In their article, Messrs. Collins and Gadenne employ three very clever geometric metaphors to describe the three general types of retirement planning strategies currently used by financial advisors. They encourage advisors to consider employing the more holistic household balance sheet approach, the rectangle shape, that considers all of a household’s present and future assets and spending liabilities to determine a funded status or a current spending budget. According to these gentlemen, “This article is a call to advisors to expand beyond asset allocation pie charts and Sharpe ratio values to diagnose feasibility of goal funding and monitor the plan’s performance by helping clients ask and answer the following questions:
- Do I have enough to do what I’d like?
- How likely is it that my plan will remain sustainable under future economic environments?
- What is my capacity to meet the unknown or unexpected?”
While we have not developed a full understanding of the planning strategy they proposed, it is clear to us that it has a lot in common with our rectangularly-shaped Actuarial Approach, as both approaches employ balance sheet comparisons of an individual’s or household’s assets and spending liabilities.
Michael Kitces Post
In his post, Mr. Kitces deftly summarizes the three Collins/Gadenne geometric metaphors and his understanding of the benefits and limitations of employing each type of retirement planning strategy. In response to his question “What is the optimal shape of retirement planning?” Mr. Kitces concludes that the best approach for retirement planning may involve incorporating elements from all three shapes.
Our Take
We support the Collins/Gadenne endorsement of what we consider to be the use of basic actuarial principles in the personal financial planning process. We believe employing these principles will not only better meet the needs of clients of financial advisors, but also reduce financial advisor fiduciary liability. At the same time, however, we also support Mr. Kitces’ conclusion that an optimal consulting approach may very well involve elements from different approaches. It is exactly for this reason that we suggested in our Advisor Perspective article (originally entitled “Give Your Clients Another Data Point Each Year to Help Them Make Better Financial Decisions”) that financial advisors supplement their client consulting (i.e., not necessarily replace what they are doing) with calculation and explanation of the client’s Actuarial Budget Benchmark (ABB).
Mr. Kitces is critical of the sensitivity of the rectangle approach to the use of different discount rate assumptions to determine present values of assets and spending liabilities. He indicates:
- that there is little agreement on the appropriate discount rate to use,
- “nothing on the household balance sheet directly conveys the greater risk that is inherent in assuming a higher discount rate”, and
- “two advisors using the same rectangle approach may still come up with substantively different conclusions and recommendations about whether the prospective retiree is on track!”
