Saving for retirement without sacrificing lifestyle

Q I am saving as much as I can toward my retirement but have no idea if I am currently sacrificing lifestyle by saving too much for the future. There are trips, purchases, home renovations and other extras that my family and I are putting off that would make life more enjoyable now. However, I am concerned that I will have a shortfall at retirement. Is there a method by which I can have more certainty in my planning for retirement?

A This is an excellent question because it relates to current lifestyle as well as future planning. You used the word sacrifice and, since you only go around once, why would anyone want to needlessly diminish the quality of life that they could currently enjoy? Your question brings up significant issues, which call into question the very premise of traditional financial planning.

Following are several aspects of financial planning that we think will help to uncover what we consider "inconsistencies" and "contradictions" in the way most people plan for their retirement, as well as the approach they take in planning for their short and intermediate goals in life.

Most retirement analyses use a set of assumptions to calculate how much someone should save for retirement.

In part, these assumptions include current assets, age of retirement, inflation rate, rates of return, income tax rates, social security benefits, mortality ages, investment portfolio allocation and projected savings.

The first flaw that we find in traditional planning is the use of average rates of return. We strongly recommend against using average rates of return in a financial planning process because, as we all know, most investments do have volatility.

Other than short-term treasury bills, CDs and money market accounts, almost all investments have a standard deviation from their average annual rate of return over any time period.

To rely on an annual fixed average rate of return is to say that the Dow Jones Industrial will return, as an example, exactly 12.1 percent per year for the next 50 years. To use averages is to imply that there is no risk or standard deviation to investing.

If this were true, then markets as they occurred during 1973-1974 and 2000-2002 would have no effect on your planning. Of course this is not true, as volatility in market values, especially during the withdrawal stage of the investment cycle, can have a monumental impact on someone's financial security.

Here is an example of a married couple that consulted a financial planner: Both were 55 years of age, had $900,000 in their 401(k) and intended to invest an additional $16,000 per year. They desired to retire at age 61 on $112,500 per year. They were planning for a 40-year time horizon and have decided on an asset allocation of 55 percent large cap stocks, 25 percent small cap stocks, 18 percent bonds and 2 percent cash.

A portfolio allocated in this manner over the ten-year time period ending December 31, 1999 produced a compound rate of return of 15.4 percent. However, the planner who did these calculations considered that this approach was too aggressive and, to be prudent, used returns over a longer time frame of 40 years, e.g. 1960-2000.

This reduced the "average" rate of return that the planner used in the analysis to 12.23 percent. According to this traditional method of projections, this planner informed the couple that they would not only have sufficient cash flow for life, but that his projections showed that they would end up with $23,000,000 in invested assets at age 94, their joint age of mortality.

This investment profile is hypothetical, and the asset allocations are presented only as examples and are not intended as investment advice. Please consult your financial advisor if you have questions about these examples or how they relate to your own financial situation.

However, when using another form of analysis, one that we feel is infinitely more accurate at forecasting, which we will discuss below, we found that this couple would have run out of money at age 85. A gap like this is unacceptable, and should cause concern for any intelligent investor.

It is true that years ago it was virtually impossible to use regressive analysis, because computers and programs were not yet developed that could handle these extensive calculations.