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What’s Behind the Assumptions in Your Financial Plan?

February, 2024

Mike Moore, CFP®, CIM®


The assumptions used in a financial plan are a key element. Here’s how some of them have evolved over the years.


One of the keys to proper financial planning is how financial planners manage the assumptions they use for their clients. Providing realistic projections will help ensure that these plans are achievable and offer a path for clients to confidently reach their goals. Over the years, assumptions in financial planning have evolved, reflecting the dynamic nature of the global economy and societal shifts.


Financial planners rely on relatively stable and predictable historical factors when formulating assumptions. Certain credible industry associations annually publish their guidelines for advisors to follow. These guidelines are based on a mix of long-term historical data, actuarial reports and expectations from industry firms, and should be carefully considered on a client-by-client basis.


Inflation rates, for instance, were often considered with a degree of certainty. However, the more recent economic landscape of the last few years, marked by unforeseen events and global uncertainties, has forced planners to consider assumptions regarding future inflation. Although the long-term projections should come back to the normalized long-term targets of 2-3%, these shorter term increases in cost of living, show the importance in having flexible financial plans that are able to handle increased income needs when they arise over shorter time periods.


The traditional fixed retirement age has also been challenged by changing work patterns. Phased retirements, extended careers, and longer life expectancies have led to a reconsideration of assumptions about when individuals might retire and how their income will change over time.


Life expectancy, which has been influenced by advances in healthcare, has experienced a notable increase. Therefore, many financial planners are using longer life expectancy projections to ensure clients don’t see large decreases in income in those later years.


Living longer means that long-term care costs have also become a more important aspect of financial planning. As healthcare costs escalate and the population ages, planners may incorporate these potential costs into retirement income projections or allow flexibility in the plan to accommodate.


But perhaps the most significant shift has occurred in assumptions about market returns. Financial planners base their projections on long-term average returns. However, with increased market volatility, and the sharp changes in interest rates, planners need to review their returns for potential adjustments. This is especially true in fixed income investments now versus a couple years ago. Until more recently, for much of the last decade, fixed income investments such as bonds and GIC’s were not providing much return and therefore caused planners to consider a slightly more aggressive approach using more equities or alternative investments for their clients in order to reach their return objectives. But with the recent increase in interest rates these fixed income products are now able to yield more favorable returns. There seems to be a tactical shift back to this asset class as planners can now reduce risk in portfolios without diminishing the overall return potential. Of course, there is some uncertainty how long this will last as it is expected that the long-term interest rates will decrease back to lower ranges.


One of the more difficult assumptions for planners’ is determining a client’s income need. Understanding their spending pattern, risk tolerance and behaviour is often difficult to predict. Enjoying the early years of retirement comes with extra costs for potential travel, home improvements, etc. Learning to live on a fixed income can be a difficult transition for some and this is where having safe assumptions with some added flexibility can be important.

In summary, financial planning assumptions have evolved and reflect the many complexities in today’s financial landscape. Financial planners have had to adapt to these changes to ensure clients continue to experience the retirement outcomes they seek. Since it is impossible to predict short-term movements in investment returns, interest rates and inflation, it is important that planners use prudent long-term assumptions in financial plans. The one size fits all approach will not work, therefore tailoring a plan specifically to each client’s unique situation is indeed the best approach. As with many things, the more time and careful attention you provide to planning, the better the outcome.


Author:

Mike Moore, CFP®, CIM® is a Client Relationship Manager with Louisbourg Investments. Comments or questions may be submitted to Mike at Mike.Moores@louisbourg.net.



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This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. If you are not sure how to proceed with a request for further information, seek help from a professional. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.

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