Executive Summary:
A well-crafted retirement plan is essential for navigating your financial future, especially as you approach or enter retirement. However, a plan built on unrealistic assumptions can paint a deceptively rosy picture, leading to misguided decisions and potentially jeopardizing your financial security. Understanding the critical elements that contribute to an accurate and robust financial plan is key to achieving your goals.
Crucial Assumptions for a Solid Financial Plan
Realistic assumptions are the bedrock of any effective financial plan. Here’s a look at some of the most important factors to consider:
- Return Assumptions: Historical stock and bond returns offer a starting point, but current market conditions may require adjustments. For example, if bond yields are lower and stock valuations are higher, it’s prudent to use more conservative return assumptions. In other words, if the 10-year expected return, based on today’s valuations, for a balanced portfolio (60% stocks and 40% bonds with global exposure for purposes of this example) is 5.3% (Research Affiliates, 2025), but the historical 10-year average return for a similarly allocated portfolio has been ~7% (Vanguard, 2024), using the higher, historical returns in your plan is not only unrealistic but also poses significant risks which are covered at the end of this article.
- Advisory Fees: A comprehensive financial plan must account for advisory fees. Ignoring these fees can significantly inflate projected returns and thus overstate portfolio growth.
- Spending Assumptions (The Retirement Smile): Retirement spending isn’t static. It often follows a pattern known as the “retirement smile.”
- Go-Go Years (assumed first 10 years of retirement): The initial years of retirement often involve increased spending due to pent-up desire for travel, home improvements, and other activities. Spending during this period typically increases with inflation.
- Slow-Go Years (assumed years 10-20 of retirement): Spending tends to decrease in this phase as travel slows, and major purchases become less frequent. Health issues may also begin to emerge, leading to a reduction in activity-based expenses.
- No-Go Years (assumed last 10 years of retirement): Towards the later stages of retirement, expenses often increase again, primarily driven by healthcare expenses, especially long-term care needs. A good financial plan should model this dynamic spending pattern.
- Inflation Assumptions: Not all inflation is created equal! The Consumer Price Index (CPI) is useful for day-to-day spending, but certain areas of your financial plan require custom inflation rates.
- Healthcare Inflation: Healthcare costs typically inflate at a higher rate than general consumer prices. This applies to both regular medical expenses and long-term care.
- Social Security Cost of Living Adjustments (COLAs): Social Security COLAs are calculated using a different formula than CPI and tend to be lower than “actual” inflation. Your plan should account for the tendency of Social Security benefits to decline in purchasing power over time.
- Overlooked Expenses: Many people underestimate their true spending, often compartmentalizing expenses. A thorough financial plan should meticulously account for all potential outlays.
- Travel Expenses: Even if travel spending is inconsistent, building in a realistic estimate of average travel expenses ensures these are properly reflected in the plan.
- Housing Costs: While property taxes, insurance, and HOA fees are the big-ticket expenses, smaller maintenance costs add up over time. These can be significant and easily overlooked.
- Car Purchases: Instead of lumping car expenses into general living costs, consider building separate purchase goals for vehicles throughout retirement, accounting for frequency and projected costs.
- Long-Term Care Costs: You may or may not need long-term care insurance. However, you definitely need a plan for potential long-term care costs. Make sure long-term care is factored into your plan.
Stress Testing Your Retirement Plan
Nobody can predict the future. Life and markets are unpredictable. Retirement planning stress tests help assess your plan’s resilience to unfavorable surprises. They identify key risk factors for a financial plan.
Stress tests can model various “what-if” scenarios, for example:
- A sudden and significant drop in the stock market (e.g., 20% immediate decline).
- Reduction or elimination of Social Security benefits.
- Higher-than-expected inflation.
- Lower-than-expected investment returns.
- Increased taxes.
- Longer-than-assumed life expectancy.
These tests assign a probability of success for each scenario, indicating the likelihood of meeting your goals even if these challenging events occur. This kind of analysis provides a concrete, quantifiable assessment of your plan’s robustness. Favorable probabilities of success for achieving your goals and income needs with stress tests included may significantly alleviate anxieties about market volatility, political uncertainties, and other risks.
A separate long-term care stress test is also crucial. This models significant long-term care expenses towards the end of your plan to determine if self-insuring is viable or if an insurance solution is necessary. This test may use a very conservative (even unrealistic!) scenario to assess your plan’s ability to withstand significant long-term care costs.
Identifying and Addressing Unrealistic Assumptions
Determining if your financial plan uses sound assumptions can be challenging for individuals who are not financial professionals. Here are some indicators of a potentially problematic plan:
- Unrealistically High Returns: If your plan projects investment returns significantly above long-term historical averages (e.g. 15% annualized stock returns over 30 years), it’s likely too optimistic.
- Missing Fees: A plan that doesn’t explicitly account for advisory fees or other costs does not provide a complete picture.
- Generic Inflation: Relying solely on a single, general inflation rate without considering higher inflation for specific categories like healthcare is a red flag.
- Lack of Detailed Spending Projections: If your plan doesn’t break down spending beyond basic living expenses or overlooks common retirement outlays like travel, home maintenance, or new cars, it may be underestimating your needs.
The consequences for an unrealistic plan may be dire:
- Premature Retirement: You might believe you can retire earlier than is financially feasible.
- Overspending: You could outspend your financial resources in retirement.
- Inadequate Legacy: The amount you leave to loved ones or charity may be significantly less than desired—there may not be anything left to leave at all.
- Inappropriate Risk Level: A plan that paints too rosy a picture may understate investment risk and leave your retirement vulnerable to a bear market. Conversely, assumptions that are too conservative may force you to adopt goals and lifestyle spending significantly below what you can actually afford.
Financial planning is not a “set-it-and-forget-it” exercise! A financial plan should be a dynamic document that is updated regularly (we prefer intervals of six months). These updates will account for changes in goals, market conditions, and your personal circumstances. Regular updates mean small course corrections can be made promptly, smoothing the ride to achieving your retirement goals.
If you suspect your current financial plan is based on inaccurate or overly optimistic assumptions, seeking a second opinion from a qualified advisor is the critical next step. Addressing these issues early can help prevent significant financial setbacks later.
Author: Ryan Wyatt, CFP®, CIMA®
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This communication is provided by Wyze Wealth Advisors LLC, a registered investment adviser. All material is for informational and educational purposes only and should not be considered personalized investment advice or a recommendation regarding any specific security, strategy, or product.
The assumptions and scenarios presented are illustrative and do not reflect actual investment results. Projections are based on current market conditions, which may change. Past performance is not indicative of, and does not guarantee, future results. All investments involve risk, including the potential loss of principal.
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