Assumptions for financial planning Robert Lockie FIFP CFP CM
You don t need assumptions if you can reliably and consistently predict the future
General considerations Real or nominal? Forward-looking Pre- or post-tax? Pre- or post-costs? Spurious precision Test the sensitivity Regular reviews
Inflation Purpose RPI or CPI? Expenditure Earnings is your client average? http://www.ons.gov.uk/ons/taxonomy/index.html?nscl=price+indices+and+inflation http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/march-2013/table-earn01.xls
Inflation data 10% 9% 8% 7% 6% 5% CPI annual rate RPI annual rate CPI annualised rate RPI annualised rate 4% 3% 2% 1% 0% Jan-13 Jan-12 Jan-11 Jan-10 Jan-09 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 Jan-92 Jan-91 Jan-90 Jan-89
Impact 1,000,000 900,000 800,000 700,000 600,000 2.0% inflation 2.5% inflation 3.0% inflation 3.5% inflation 4.0% inflation 4.5% inflation 5.0% inflation 500,000 400,000 300,000 200,000 100,000 - Start 5 10 15 20 25 30 35 40
Education costs http://www.isc.co.uk/research_iscresearchpublications.htm Is your child s school average? University costs? 10% 9% 8% 7% 6% 5% 4% 9.6% School fees escalation RPI change 7.5% 7.0% 6.7% 6.3% 5.7% 5.8% 5.9% 5.7% 5.9% 4.5% 4.6% 4.5% 4.0% 3% 2% 1% 0%
Long term care costs Current average c.3.5% ahead of inflation Look behind the figures Average may not be what your client pays
Average age at death Mortality 120 110 100 Life expectancy Assumed life expectancy 99 90 80 70 60 50 40 30 20 10 - Males Females 0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96 102 108 Age now
Annuity rates Determining factors Long bond yields Mortality expectations Frequency and timing of payments Costs Other factors Use current rates or actuarial principles? Have a default basis?
Investment returns Asset class or wrapper-based? Which is the main driver? Where do the differences in returns arise?
Cash & bonds Cash Government bonds Nominal Index-linked Corporate bonds
Cash & bond risk factors Cypriot bank deposits More risk, more return Default risk Less risk, less return Short gilts Long gilts Maturity risk
Why own long bonds? 12% 10% 8% Risk and return from bonds 1964-2002 Annualised compound return Annualised standard deviation 6% 4% 2% 0% 1 month 6 months 1 year 5 years 20 years Maturity
Cash & bond returns Inflation + Maturity premium + Default premium
Equity returns UK, US, EU, Japan, Pacific, emerging? OR Global thematic? OR Market, value, small?
Small capitalisation companies INCREASED EXPECTED RETURN Growth companies (low BtM) Market portfolio of all equities REDUCED EXPECTED RETURN Value and small cap effects cancel out along purple line Large capitalisation companies Value companies (high BtM)
Asset class returns 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Inflation Equity market Equity value Risk-free Equity small cap 2% 1% 2% 1% 4% 4% 4% 4% 2% 2% 2% 2% 2% 2.5% 2.5% 2.5% 2.5% 2.5% Risk-free Equity market Small cap Value Small cap value
compositions 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% Global property Emerging markets equity International market equity UK market equity Index-linked bonds Global short bonds Cash 0% 1 2 3 4 5 6 7 8 9
Derived portfolio returns 9.00% 8.00% 7.00% Diversified growth Defensive 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 0 20 30 40 50 60 70 80 100
Costs Underlying asset costs (TER) Third party management costs Advice & planning costs Custody & wrapper costs turnover costs Hidden costs Taxes
Impact of costs 2.5% 2.0% 1.5% 1.0% annual cost comparison (before tax) 0.52% 0.20% 0.47% 0.00% 1.08% 0.5% 0.0% 1.04% Existing portfolio Underlying assets Custody 0.52% Recommended portfolio Management Transactions (assumed)
A cautionary tale for spreadsheet users Year Fees Fund at Fund at Growth start of year end of year 2011 10,000 200,000 206,000 196,000 2012 10,700 196,000 201,880 191,180 2013 11,449 191,180 196,915 185,466 2014 12,250 185,466 191,030 178,780 2015 13,108 178,780 184,143 171,035 2016 14,026 171,035 176,166 162,141 2017 15,007 162,141 167,005 151,998 2018 16,058 151,998 156,558 140,500 2019 17,182 140,500 144,715 127,533 2020 18,385 127,533 131,359 112,975 2021 19,672 112,975 116,364 96,692 2022 21,049 96,692 99,593 78,545 2023 22,522 78,545 80,901 58,379 2024 24,098 58,379 60,130 36,032 2025 25,785 36,032 37,113 11,327 2026 27,590 11,327 11,667-15,923 Fees assumed to increase at 6%pa assumed to increase at 4%pa 200,000 150,000 100,000 50,000 - - 50,000 Fees Fund at end of year 2011 2013 2015 2017 2019 2021 2023 2025
A better approach Year Fees Fund at Fund at Growth start of year end of year 2011 10,000 200,000 208,000 198,000 2012 10,600 198,000 205,920 195,320 2013 11,236 195,320 203,133 191,897 2014 11,910 191,897 199,573 187,663 2015 12,625 187,663 195,169 182,544 2016 13,382 182,544 189,846 176,464 2017 14,185 176,464 183,522 169,337 2018 15,036 169,337 176,111 161,074 2019 15,938 161,074 167,517 151,579 2020 16,895 151,579 157,642 140,747 2021 17,908 140,747 146,377 128,469 2022 18,983 128,469 133,607 114,624 2023 20,122 114,624 119,209 99,087 2024 21,329 99,087 103,051 81,722 2025 22,609 81,722 84,990 62,381 2026 23,966 62,381 64,877 40,911 Fees increases 6% growth 4% 200,000 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 - Fees Fund at end of year 2011 2013 2015 2017 2019 2021 2023 2025
So how did we do? 15% 14% 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Assumption Actual 03/2004-02/2013 Index-linked gilts MSCI Emerging Markets FTSE World ex-uk FTSE All Share Cash Earnings (to 12/2012) CPI RPI
What about the experts?
What about the experts?
It is tough to make predictions, especially about the future. Yogi Berra
At the end of the day.. expect all your assumptions to be wrong and tell your clients that you do
and expect the unexpected
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