Think Like An Actuary To Become A Better Financial Advisor

Think Like An Actuary To Become A Better Financial Advisor
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Think Like An Actuary To Become A Better Financial Advisor

September 7, 2015

by Ken Steiner

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Developing a reasonable spending budget for clients who are near or in retirement is an actuarial problem. As such, it requires an actuarial solution. But, you don’t need to be an actuary to solve your client’s problem.

All you need are some consulting skills, number-crunching abilities and the proper tools and processes. This article will point you toward those tools and processes and tell you why you and your clients will benefit from using what I call “The Actuarial Approach” for determining spending budgets.

I’m a retired pension actuary with over 35 years of experience working at consulting actuarial firms. When I retired a little over five years ago, I started a website to help retirees determine how much of their non-annuitized assets they can afford to spend each year as part of the overall process of developing a reasonable spending budget. Here is a link to the website.

On the website, you will find several explanations of The Actuarial Approach, two simple spreadsheets (one for general use and one for a retiree who wants to defer commencement of Social Security benefits) and a Blogspot that contains periodic posts from me on various decumulation topics. You will notice in my bio that I justifiably claim to have no expertise in either investing or financial planning and that I receive no direct or indirect compensation from any activities associated with the blog or website.

Survey says: Most financial advisors not using math and science

In a survey by Russell Investments published last fall, 234 financial advisors were asked how they develop spending budgets for clients who are approaching or in retirement. A quarter responded that they based their approach on levels of pre-retirement spending; 22% indicated that they used a rule of thumb like the 4% rule; 19% indicated that they used some variation of the bucket strategy; 16% indicated that they compared assets with future liabilities and 18% indicated some other approach. The survey concluded that not enough advisors were using “math and science” to develop spending budgets for their clients.

Advisors should be periodically comparing the client’s assets with the client’s liabilities, in a similar way actuaries measure the funded status of pension plans. The authors said that while using a rule of thumb is easy to understand, “it doesn’t account for a client’s individual circumstances.” Thank you, Russell Investments, for your indirect plug for the Actuarial Approach.

The Actuarial Approach

The Actuarial Approach indeed uses “math and science” to develop spending budgets by periodically (generally annually) aligning the retiree’s assets (accumulated savings, Social Security and other sources of retirement income such as pension benefits or annuities) with the retiree’s liabilities (the present value of future spending needs). While this sounds complicated, it is easily accomplished by entering a few data items and assumptions in one of the two spreadsheets that reside on my website.

While the Actuarial Approach can be used to produce a total spending budget for the year, I encourage advisors to break their client’s total budget into several component parts or categories, such as non-health-related essential expenses, essential health-related expenses, non-essential expenses, bequests or other end-of-life expenses and emergency expenses. Clients may have different expectations for these separate categories (in terms of expected length of payment or expected/desired rate of future increase) that may affect current budgets and investment strategies.

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