I’ve come across lots of rules about how much money you’ll need for a happy, comfortable retirement. And all sorts of numbers, and all sorts of ways to calculate them. When I saw what colleagues of mine came up with, about what it really means to be rich, I loved the simplicity of their concept.
Wouldn’t it be wonderful to be able to say “I’m rich!” – and mean it? Read on.
In 2011 I was delighted to be invited to write the foreword to a book called Someday Rich by former colleagues of mine, Tim Noonan and Matt Smith (published by John Wiley). I would love to have written the book, but I wouldn’t have done half as good a job. The book is addressed to financial professionals (“advisors” in American parlance). It’s written by veterans in the business of individual financial planning and of helping those professionals in two ways: how to do more sensible things for their clients and how to run an efficient practice. It taught me a lot of things about financial professionals that I didn’t know.
Here’s an extract from my foreword. It deals with two things. First, what does it mean to be rich? And second, how should I interact with my professional?
I think you’ll find it consistent with the “informed consumer” notion that I set out in Post #2. Here’s the extract.
I’m not an advisor, I’m a client. Of course I want my advisor to be successful; the relationship won’t last otherwise. But what that takes, I don’t know. The authors do, and that’s a big part of this book.
For my part, I start with some questions.
Am I rich? (I use “I” to mean my wife and me together: we’re an indivisible unit.) I like the authors’ definition of rich – it’s not an absolute number, it just means that I’ll have something to leave after I’m gone. If so, my assets will support my lifestyle for as long as I live. And that will be a huge relief to me, and a wonderful achievement. The whole book is based on that as its fundamental premise. Good!
The focal point of the authors’ assessment of richness is based on a measure that technicians have long used in defined benefit pension plans: the funded ratio. First, calculate how much money, how large an asset base, it will take to support the client’s lifestyle. (They show you how.) What proportion of that amount do the client’s actual assets represent? That’s the funded ratio. Above 100% is rich, below 100% requires action. Well, above 100% also requires action, but there’s a clear psychological dividing line between striving for security that you don’t yet have, and buttressing security that already exists.
What’s my role in all of this, as the client? I need to understand myself: my lifestyle, my goals, my psychological make-up, my decision-making quirks, how I am likely to react to good times and bad. I don’t need to know as much as the advisor. I don’t need to be able to create the advice myself; I do need to know enough to assess the advice I’m given, and challenge it. And then, when we agree on a plan and its implementation, I have to share responsibility for its acceptance. This is a partnership.
There’s homework to be done. This book gives me the education and the tools, including fascinating insights into different human temperaments. I don’t just want a good advisor; I also want to be a good client. As far as the relationship is concerned, I’m glad to find that my needs and goals need to be the focal point of the advisor’s advice and actions. I don’t want a conflict of interests. All of that becomes clear.
OK, now I’m ready. Talk to me, discuss with me, plan with me, advise me, implement my plan, monitor progress with me. As Dr Frasier Crane used to say in the TV series Frasier: “I’m listening.”
That’s the extract.
I’ll discuss your personal funded ratio and how to calculate it in some detail in later posts. For now, all that’s necessary is to note that it’s a rough and quick way to give you an indication of where you stand relative to income security after you retire.
Let me also take the opportunity to introduce the notion of three pillars. Techies, such as retirement professionals, think of your security as built on a structure that is supported by three pillars.
Pillar 1 is the most general: the post-work arrangements for all members of a society. Think of Social Security in the USA, the state pension in the UK, the Dutch AOW pension, the Canada/Quebec Pension Plans and Old Age Security, age pensions around the world, that sort of thing. Pillar 3 is the most personalized: the post-work arrangements arising from an individual’s own savings. What’s the middle one, Pillar 2? It’s the set of arrangements arising from employment: the workplace pension plans, schemes, funds (names vary around the world) that are established for the benefit of employees of an enterprise or for a connected group of enterprises, like all members of a union or all enterprises in an industry.
We never think of some of them, particularly those arising from Pillar 1, as part of our personal wealth. But they all contribute to our post-work security. And so all of them will be relevant in discussing our personal funded ratio. But that’s a discussion for another day.
If your assets are enough to support your lifestyle for as long as you live, with something to leave after you’re gone, you’re rich.
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.