In Episode 25 and Episode 26 of their “Retire With Style” podcasts, Dr. Wade Pfau and the Retirement Researcher team discuss the benefits of constructing a household balance sheet to measure the adequacy of household assets vs spending goal liabilities. They call the ratio of household liabilities to household assets “the Funded Ratio.” The information contained in the balance sheet, including the Funded Ratio, combined with results of their Retirement Income Style Awareness (RISA) Profile (discussed in our post of October 6, 2021) serves as the basis for their recommended household retirement plan.
Not surprisingly, we think that constructing a household balance sheet using basic actuarial and economic principles is an important element of good retirement financial planning and therefore, we applaud Dr. Pfau and his group for sharing their approach, and we encourage our readers to listen to their podcasts. We agree that their approach produces a much more robust planning tool than Monte Carlo models frequently used by financial advisors or Systematic Withdrawal Plans (SWPs) such the 4% Rule or the RMD rule.
In this post, we will briefly discuss the similarities and a few of the differences between the household balance sheet anticipated by the Retirement Researcher team (RR) and the Actuarial Balance Sheet produced in our Actuarial Financial Planner.
Similarities Between Approaches
- All assets and spending liabilities are considered
- Present values of assets and liabilities are determined using deterministic assumptions for discount rates/investment returns, lifetime planning periods and inflation/expected future increases.
- Reliable (or non-risky) asset present values are compared with essential spending liabilities in addition to comparing all retirement assets with all spending liabilities
- Reflects present value of non-linear sources of assets or non-linear spending liabilities
- May be future cash-flow issues if income is assumed to occur later in retirement (i.e., inheritances, future home sales, deferred annuities, etc.)
Significant Differences Between Approaches
- We allow users to assume a higher discount rate for determining the present value of discretionary spending liabilities and assets dedicated to fund such liabilities. RR uses one discount rate tied to TIPs yields for all discounting purposes. Our default discount rate for determining the present value of essential expenses and non-risky investments is tied to assumed discount rate used to price inflation-indexed annuities. Our assumptions can be overridden.
- RR uses Retirement Income Style Awareness Profile to determine investment style and risk preferences. We ask users to manage investment between risky and non-risky assets and other risk tolerance choices through the process used to select essential expenses.
- We permit inputting of non-recurring expenses, an assumption for percentage reduction in recurring expenses on the first death within the couple and different rates of future expense increases to reflect non-linear nature of household expenses
Bottom line
If you
like the household balance sheet approach discussed by the Retirement
Researcher, you are going to love our Actuarial Financial Planner. We
encourage you to listen to these two podcasts for different explanations
of how and why you should create your personal household balance
sheet.
