Capitalist Investor

Preparing for the Unexpected: Improving Your Financial Plan for Any Scenario, Ep. 284

• Strategic Wealth Partners

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Welcome back, listeners! This week's episode of the Capitalist Investor featured Diamond Hands Derek and Cool Hand Luke, who took the current chill in the air as an opportunity to dive into the intricacies of financial planning. With football season casting a refreshing aura around, Derek and Luke expertly weaved through essential components of financial planning. Here are the five hot topics they discussed on this episode — Episode 9-11.
1. Lower Returns
The cornerstone of any financial plan is understanding and anticipating returns. Derek highlighted the importance of incorporating lower-than-historical returns in your financial projections. Historical returns aren't necessarily indicative of future performance, particularly given the economic shifts over the past decade. Derek mentioned that their blended rate of return is currently around 5.15%-5.2%, compared to historical rates in the range of 6.5%-7%.
2. Bear Market Scenarios
One of the key elements of a robust financial plan is preparing for potential bear markets, especially the one that could coincide with your retirement year. As Derek noted, nobody wants to face a 20-30% portfolio dip right when they retire. By running simulations that include bear market conditions, financial advisors can help determine how resilient your plan is against market downturns, ensuring that you won’t have to go back to work or drastically alter your living standards during retirement.
3. Social Security Cuts
Social Security is a significant topic, especially considering its current uncertain future. Luke and Derek underscored the importance of planning for potential Social Security cuts. While it’s not certain if and when Social Security will be reduced, anticipating a potential 25% cut can prepare your financial plan to withstand such scenarios. The key takeaway was to not solely rely on Social Security for your entire retirement income.
4. Higher Taxes
No financial plan is complete without considering the impact of taxes. Derek pointed out that the government’s spending habits make higher taxes a likely future scenario. Building your retirement plan around current tax rates may give you an overly optimistic outlook. Running scenarios with higher taxes will provide a more realistic view of your future financial landscape and help you in strategizing moves to mitigate future tax burdens.
5. Inflation
Inflation has been a trending topic this year, and its impact on financial planning is substantial. From 2007 to 2020, inflation was relatively benign, averaging around 2.2%. However, recent spikes mean that inflation rates need careful attention. Derek emphasized using a reasonable inflation rate, currently about 3%, to forecast long-term financial requirements accurately. Additionally, Luke highlighted keeping an eye on unused cash and its returns, stressing that today's higher return rates on cash are unlikely to last forever.

These five hot topics encapsulate critical considerations for anyone serious about financial planning. By examining lower returns, bear market scenarios, potential Social Security cuts, higher future taxes, and inflation, Derek and Luke provide a comprehensive guide to ensuring your financial plan is resilient under various conditions. Whether you're nearing retirement or just starting your financial journey, these insights offer a roadmap to navigate the uncertainties of the financial landscape.
Stay tuned for more expert advice in upcoming episodes of the Capitalist Investor. If you have any questions or topics you'd like Derek and Luke to cover, don’t hesitate to reach out at @swpconnect.com. Until next time, keep those financial strategies sharp!

Hello and welcome to this week's episode of the Capitalist Investor. As always, you have me, diamond hands D, and cool hand Luke. What's going on, man? What's up? So now that football season is here, I know I am happy. There's a little chill in the air and nothing like talking football and then also talking about financial planning. I'm just. I want to get outside more. Like, I like, is the chill in the air. Like, I felt it was, like 60 degrees two days ago. Whatever. It's great. I love fall. You know, anything above 70 here in Ohio is too hot for me. Give me 55 to 70 degrees and, you know, give me 40 degrees, I'll be out there still in shorts. Like, I don't know, it's. I like this time of year. That's a Midwest thing. It smells different. It smells. The. The air smells different. And I like it. It really does. I feel like I can't breathe nine months out of the year. And then finally, when September, October hit, I can finally breathe the air again. Maybe it's allergies. Maybe I'm just getting old. Well, it's definitely, definitely a great time of year. So, yeah, we thought we'd talk a little financial planning today and talking about a backup plan. So, you know, obviously, financial planning quarter. We talk about financial planning, but I think this is a very pertinent one. Kind of ties into some things we talked about last time. But if you go through all the trouble to create a financial plan, the last thing that you want to do is just stop at the perfect scenario where nothing bad happens ever, and you just get a nice rate of return forever and your plan works great. Right. That. That isn't really the purpose of it. The purpose of the plan is obviously to show you that you can make it, but then protect you along the way as well. So let's kick things off with something we mentioned a little bit last time, lower returns. So I've seen, you know, many financial plans come through here. You know, obviously, before we're working with the people that either have a flat rate of return or a historical rate of return. And I think it's fairly obvious to see with so much of the returns pulled forward that we've seen over the last 10, 12, 15 years, that I don't think we're going to realize historical returns. So if you're putting historical returns in your plan, especially if you're about to retire, and that plan might be 30 years long, if you're using those historical rates of return, you're probably going to significantly overstate your chances of success. So what we do here, obviously, we're using a Monte Carlo simulation, so we're not just using a flat rate of return. So we're getting to, like, a probability of success. But what we're doing in the plan as well is lowering the historical returns pretty significantly. I want to say we're using, like, a blended rate of return, like, a little more than 5%, like 5.15.2%, where historical blended return is 6.57%. So, yeah, you want to make sure that we're not just running one scenario, running multiple. You know, one of the basic ones that we run is a bear market in the year that you retire. So, you know, last thing you want to do is go through all this planning. You work your whole life, and then a bear market hits, and then all of a sudden, you can't retire. So bear market, a 20% drop. Just think 2008, 2009, like, you retire, and then two, right. When they retiree, Bear Stearns, Lehman Brothers collapses and your portfolio is down, like you said, 2030, 40%. Yep. So while your base case scenario might be just fine, if that happens, you're not going to be able to retire. You're going to have to go back to work. So that kind of shows. That's a really good illustration on seeing something bad. So we put in a bear market in the year that you retiree, and then we can say, hey, if that happens, what is your investment mix look like? Are you going to be down that full 20% or maybe a little bit less? Do you have any guaranteed income in retirement that can help you bridge the gap when stuff like that happens? So that is the real financial planning. It's always a couple layers deep, and you don't necessarily maybe see it at first glance, but that's what the financial planning really needs to get to. Well, then there's the opposite side. Like, I mean, I don't see it very often, but, you know, you do see it where someone does see a 20, 30% correction in the day they retire, and somehow they're still at 100% because they just, they have a large asset base, or they don't spend a lot of money. And if that's the case, you can then be more flexible and say, well, you don't need it. Hit home runs. You could hit singles or doubles. But if you wanted to hit home runs and use your portfolio as more of an estate planning tool, or as a legacy planning tool, or a charitable, charitably inclined tool down the road, leave a legacy like, then you can start actually still be aggressive throughout retirement because you have a large asset base and if you wanted to continue to grow for other reasons, you can think about it that way. I've ran into that a couple of times the past couple months to where it's just, you know, they are in a pretty good spot no matter what for the most part from a financial standpoint. And they can use it for different purposes. Yep. So that's, that's a great point. And I've actually just had a conversation last week with one of my clients who, who basically said, and said the same thing. They most certainly didn't need to hit home runs. And they basically said, hey, let's take a portion of this portfolio and get a little bit more risky with it. When you run that through a financial plan, if you say, hey, if all that money goes away, are we still going to be okay? The answer is yes, then obviously you can definitely take that risk. That doesn't mean taking risks doesn't mean you have to be careless. Right. Taking risk just means, you know, you increase what you think, you know, to your kind of base level risk. Social Security cuts in the future is another one that we talk about, especially when we're doing, you know, some educational classes around town. Social Security, we've talked about it many times. It's a complete disaster. If we just have Social Security in your plan and we have it increasing 3% per year for inflation, and we put that in forever, obviously that's going to make your plan look really good. What happens if in ten years, or whatever the case may be, the government doesn't do anything and Social Security is decreased by 25%? I'm not saying that's going to happen, but if it does, you know, how does your plan hold up? And Social Security was never designed for you to live off of solely, right. I mean, majority of people that probably listening to this are saving for retirement have a 401k. But, you know, Social Security is a tool to use to help cover some necessities, whatever it be. But then, you know, again, you have to understand, understand your, your spend. Like, you have to understand what exactly is coming out. And most people don't know what their budget is. They never actually put the time and effort into outline. Like my father, like, you know, bless him in his way of thinking, frugality and everything, but like he has it literally lined item, every single expense. He, I'll use this as reference. I was back home this past weekend for Labor Day weekend, and they took both of their, they have like the Kroger giant Eagle gift card or not gift card card. And they get like a dollar off a gallon for gas. So it's about a ten minute drive away to the Kroger gas station or whatever it be, and they take both of their cars and then they take two, like five gallon or ten gallon, like tanks to fuel for gas. Right. So they fill up both the cars, both two gallons or both the gallons of gas tanks, and they do 35 gallons and save, you know, a dollar, they save a dollar every time. So they say $35. But, you know, he's very conscious of every dollar coming in, every dollar coming out. And he even saves$35 going to fill up two tanks of gas. And there's a reason why my father, you know, he's, you know, they've done a great job saving. It's just because they've always been conscious of everything coming in and out. And too many people in this world nowadays don't know what's coming in. They see the money hitting the bank account, they don't know what's coming out. They just know what's left over at the end. Right. Exactly. Yep. So that, that is a very big generational divide because. Yeah, obviously, I see, see that all the time in my clients as well. You know, just because if you've saved your whole life and you've been, you know, not necessarily even frugal, just conscious of what you're spending, and then you get into retirement and your plans 100% and your max spend, you know, is $20,000 more than, than what you're actually spending. People just have a hard time spending at that point. They're just not going to do it. Right. The younger generation is the complete opposite, and it's not for everybody. But, you know, I think, you know, it's been like this pretty much through time, too. Right? You know, well, when times are good, you lose sight. Like, you know, my parents, the boomers, I mean, they went through the whole, their parents went through the Great Depression, right? So like, you know, you come out of that mentality of, you know, every dollar is important. Every dollar matters. Every dollar. You know, when time bad times hit, you want to be prepared when you have good times for so long, essentially, and then the government bailing things out, making recessions quicker and quicker. Since the Great Depression, you know, if you look at every recession since the Great Depression or since Federal Reserve was created, it's gotten shorter and shorter and shorter throughout time because of government bailouts, stimulus, printing money, whatever it be. So when you get used to that mentality of bailouts and presidents being sent and times are pretty good for the most part, you don't need, you'll have the mentality that you don't need to save money. You don't need to have an extra cushion. It's that kind of mentality that's kind of flooded the system. Yep, for sure. All right, backup plan, two more quick ones and then we'll get out of here. So when we talk about all the time, higher taxes. So this is going to happen, you know, again, it's not a political statement just based on how much we're spending. You know, the, the Trump administration didn't seem too hot on cutting spending last time they were in office. So taxes are going to go up in the future. So building your whole entire plan on today's tax rates, again, probably not what you want to do. Obviously, you want to see how that looks first, but you want to run some what if scenarios for, hey, what if taxes go up in the future? What is that going to do to my plan is all of my money in qualified plans, meaning a tax hike is going to greatly affect me. What can I do now to maybe make that burden less in the future? So those are, you know, things we've talked about before, but something that is obviously going to happen. I think we talked a couple weeks back on the democratic tax, $5 trillion, I believe, tax plan taxing everything they possibly can. So we don't want to run our plan just on today's tax rules or a tax code then. The last one I think we can hit on is inflation. So this is something that we've kind of seen change in real time in the financial plans. Obviously, as we're creating financial plans from 2007 to 2020, there wasn't much inflation. Right. So we had an inflation factor in there. I believe at the time it was around 2.2%. But inflation really wasn't even that, honestly. But that number is meant to be the average inflation for the entire length of the plan. Now that we're seeing this big inflation jump, if we took people's inflation rate from 2% up to 6%, obviously that's not going to make their plans look good. I think we're at about a 3% right now. And as rates are probably going to start to come down here, I think that number is going to get closer to what reality is. But inflation is something, obviously you need to have inside of your financial plan, inflation. And on the other side, you need to be conscious of cash unused cash. What that's earning. If your financial advisor is using four or 5% cash yield right now, because rates are at the four or 5%, that's not going to last forever as well. So inflation can work obviously against you, but it can work for you on the cash, on use cash. But you want to make sure that your plan is not running much higher rate of return on your cds than you should be, that kind of thing, right? Absolutely. All right. Well, thanks for joining us this week. As we talked about, you don't want to make sure your plan is good under perfect conditions. You want to make sure it's good under all conditions. So make sure you have a backup plan there. If you guys have any questions, comments, show ideas for us, hit us up at info connect.com and we'll talk to you next week. The opinions expressed in the podcast are for general informational purposes only and are not intended to provide specific advice or recommendations for any investment, legal, financial, or tax strategy. It is only intended to provide education about the financial industry. Please consult a qualified professional about your individual needs.